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Morningstar | Operating Pressure Grows as Owens & Minor Reports Disastrous Quarter. See Updated Analyst Note from 31 Oct 2018

Owens & Minor reported disastrous third-quarter results as it struggles with pressured pricing, increasing competition, and a turnaround strategy that is not producing much improvement. We believe the firm needs to seriously consider alternative operating strategies, which could include a sale. Owens' capital structure is also challenged, as the company announced a 60% cut to its dividend in order to preserve cash for restructuring and operational improvement investments. After factoring in these latest developments, we are cutting our fair value estimate to $10.70 per share from $17.10 and are reiterating our no-moat rating. Owens is facing severe headwinds as competition has increased significantly and customers look for the lowest-cost options in the wholesale consumable medical market--trends we believe will continue over the foreseeable future. Also, the firm’s turnaround strategy is taking materially longer in producing expected improvements. Thus, our confidence that management will be able to reposition the firm to drive long-term profitable growth has weakened.

The quarter reflected the major headwinds weighing on Owens as organic revenue growth remained modest and profits remained compressed. From our perspective, the company's headwinds are intensifying, and the ability to fully recover seems less likely. The combination of increasing competition from better-capitalized players and compressing operating margins leads us to believe the pricing environment has deteriorated dramatically. Given this dynamic, we have adjusted our operating margins to account for a less robust recovery in profits, given the impaired pricing and our belief the firm may not be able to fully offset the pressures with its major restructuring efforts.

Owens’ management team has implemented a major restructuring plan, which encompasses a material realignment of its cost structure. While we applaud these efforts, we are skeptical that they will be enough to offset the issues plaguing Owens. We now model operating margins to only return to 1.3% by the end of 2022 (marginally up from 1% at the end of 2017). For context, the firm historically has produced average operating margins in the 2%-2.4% range.

From our perspective, the options available to Owens are narrowing. We believe Owens will face an extremely tough operating environment over the next several quarters, even with its new strategy, and it may be in a situation where it cannot offset its gross margin compression with enough scale or centralized cost cuts. We would highlight the loss of its biggest client earlier in 2017 and the prospect of having to compete with well-capitalized and determined new rivals as indications Owens may need to seek strategic alternatives. Chief among these would be a sale to a larger rival looking to obtain a sizable client book and distribution assets.