In a recent article about AA and Saga, I discussed the perils of investing in companies floated on the stock market by private equity owners. As a rule, I’m wary of such businesses in their early days as public companies, on the cynical view that there’s every chance they’re over-priced, over-indebted and under-invested.
However, I made an exception with medical products and technologies group ConvaTec (LSE: CTEC) when I wrote bullishly about it within six months of its October 2016 flotation. The tip has been a disaster. The share price was 303p at the time and is now around 134p.
I got ConvaTec badly wrong. But have we finally reached a point where the time to buy is right?
Attractive business characteristics
I’m a fan of the healthcare sector generally, due to strong growth fundamentals provided by ageing populations. And I felt ConvaTec was a particularly attractive proposition, because of its focus on “therapies for the management of chronic conditions,” and its “leading market positions in advanced wound care, ostomy care, continence & critical care, and infusion devices.”
It was these business characteristics, together with a strong set of maiden annual results as a listed company, in March 2017, that persuaded me to tip the stock. However, things soon went wrong.
The company issued a shock profit warning in October 2017. It said this was largely due to supply issues, arising from a move of manufacturing lines from the US to the Dominican Republic. Temporary and fixable, I thought, and remained bullish on the stock at 180p.
A year later, we had a second profit warning. This was accompanied by the departure of chief executive Paul Moraviec with immediate effect, and non-executive director Rick Anderson (former chairman of Johnson & Johnson) taking the helm as interim chief executive. The company said the primary reason for this profit warning was a change in inventory policy by the biggest customer of its infusion devices division. These things can happen, I thought, and remained bullish on the stock at 140p.
Last month, ConvaTec released its latest annual results and interim boss Anderson’s strategic review of the business. He had some blunt things to say about the company’s commercial and operational execution failures, and he reckoned investment of $150m over three years is needed to put things right.
On the positive side, he concluded: “The fundamental opportunities of our markets, products and brands remain sound.”
Time to buy now right?
There are other positives. Despite its troubles, ConvaTec has remained profitable and cash generative. Current net debt of $1,305m and a net debt/EBITDA ratio of 2.7 are down from $1,510m and 3.0 two years ago. It’s forecast to continue being profitable and to maintain its dividend at $0.057 (4.35p at current exchange rates), giving a handy yield of 3.25%.
When I first tipped the stock, the forward price-to-earnings (P/E) ratio was 19.7 (on a par with sector peers like Smith & Nephew). Today, it’s just 12.5.
I made a big mistake in allowing my enthusiasm for the sector to override my usual caution on private equity flotations, and in tipping ConvaTec far too soon after its stock market debut (lesson learned). However, having got it badly wrong, I do think the current valuation and turnaround prospects offer considerable medium-to-long-term upside potential. As such, I feel the time to buy could now be right.