Share tip of the week: medical supplier will weather the recession

By Paul Hill Aug 07, 2009

Paul Hill

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One side effect of an ageing population is that the number of people dying from cancer is rising each year. Most of these deaths are caused by "solid tumours" (eg, brain, lung or breast). The standard treatments include surgery, chemotherapy and/or radiation therapy (via focused external beams). Radiation has several advantages over the other two. It's non-invasive, avoids many side-effects and can be done on an out-patient basis.

Varian Medical is a market leader in radiotherapy. Since launching in March 2008 sales of its flagship RapidArc device have been going well – St Bartholomew's Hospital bought four last quarter, for example. But at around $350,000 each, the machines are not cheap.

And amid the recession, Varian's oncology unit (accounting for 80% of sales) in North America is being hit by two major headwinds. Firstly, medical budgets are being cut and procurement cycles are lengthening. Secondly, lower US government reimbursement rates and president Barack Obama's proposed healthcare reforms are causing many customers to wait before placing orders. However, 50% of Varian's orders come from overseas, with strong sales growth in Asia and Europe.

Varian Medical (NYSE: VAR), rated a BUY by Needham

The group's other unit supplies tubes and digital detectors for X-ray imaging in scientific, cargo-screening and industrial inspection applications. This is also being hit by the credit crunch. But I'm not put off. The long-term fundamentals are intact and, financially speaking, Varian is sound. It closed the June quarter with a $1.9bn order book and has a cast-iron balance sheet with net cash of $440m.

Wall Street expects 2009 turnover and underlying earnings per share (EPS) of $2.1bn and $2.60 respectively, rising to $2.2bn and $2.76 in 2010. After stripping out the effects of the cash pile, the stock trades on attractive Enterprise Value (EV)/operating profit (EBITDA) multiples of 7.8 and 6.6 – good value for a group with a lead position in a growing market with high barriers to entry.

Of course, there are risks. Order flow is being hurt by tightening budgets as hospitals find it harder to borrow money – especially for expensive machines. However, I expect more normal buying patterns to return in 2010/2011. Also, there are the usual potential threats from competing technology and regulatory changes. For UK investors there are also potential foreign currency issues, since half of group sales are generated in America. But these dangers are more than factored into the downtrodden valuation, and today's price looks a good entry level for patient investors.

Recommendation: BUY at $35.50

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

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