EUR 850.00 For Business Accounts Only

Morningstar | CMD Updated Star Rating from 28 Feb 2019

Narrow-moat Cantel Medical reported another soft quarter, with fiscal second-quarter financial performance falling short of both our and consensus expectations. We plan on lowering our $92 fair value estimate by a mid-single-digit percentage, although the stock appears modestly undervalued after the double-digit decline in share price after the earnings report.  While the firm saw some sequential improvement in the organic growth trajectory of the troubled life sciences and dental segments, management commentary suggests the overall path of recovery is likely to be more shallow than we had originally anticipated. As a result, we plan to lower our long-run growth outlook, specifically for life sciences, and commensurately ratchet down our cash flow projections for the business.

Many of the explanations given for the firm's decelerating growth rate were quite similar to what we heard last quarter--dental distributor inventory destocking, a lengthening order cycle, and a deceleration in U.S. dialysis clinic construction. The biggest variance that drove management's lowered fiscal 2019 outlook was attributable to the life sciences business, which we now anticipate will end the year down 5% on an organic basis compared with our prior expectations of revenue remaining roughly flat. While 2017-18 reflected boom years for dialysis clinic growth in the U.S., our five-year projection calls for clinic expansion of roughly 3%, on average, between DaVita and Fresenius. We'll lower our longer-term expectations for Cantel's life sciences segment to be nearer this rate, versus our prior forecast that assumed a rebound to mid-single-digit levels.

On the other hand, the firm's medical business has accelerated nicely with capital equipment installation back to normalized levels after a weaker second half of fiscal 2018. The segment expanded at an organic rate of 11.3%, modestly ahead of our 9% estimate, and is poised to remain the primary growth engine for the firm over time.

While fiscal 2019 is shaping up to be a frustrating year for both the company and investors, we're confident in management's ability to right the ship over the long run. Our Exemplary stewardship rating stems from the team's well-aligned incentive structure, stellar acquisition record, and ability to reinvent the business in the midst of a changing marketplace. We think these characteristics will be central to improving the firm's performance over the coming years.