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Morningstar | Owens Reports Highly Challenged 2Q; Restructuring Plan May Not Be Enough: Lowering Our FVE

After analyzing the rough second quarter, lowered near-term guidance, and our outlook for Owens’ ability to offset long-term secular headwinds, we are lowering the firm’s fair value estimate to $17.10 from $19.10 and reiterating our no-moat rating for the medical product wholesaler. The quarter reflected the major headwinds that are weighing on Owens as organic revenue growth remained modest and profits compressed materially. From our perspective, the headwinds the firm is facing are accelerating, and the ability to fully recover seems less likely. Increasing competition from better-capitalized players, along with compressing operating margins, leads us to believe the pricing environment has deteriorated dramatically. Because of this, we have adjusted our operating margins to account for a less robust recovery in profits, given the impaired pricing and our belief that the firm may not be able to fully offset the pressures with its major restructuring efforts.

Owens is facing severe headwinds as competition has increased significantly and customers look for the lowest-cost options within the wholesale consumable medical market. In response, Owens is in the process of a major restructuring plan, which encompasses a material realignment of its costs structure. While we applaud management for its efforts, we still remain skeptical that it will be enough to offset the issues currently plaguing Owens, and we have modeled operating margins to only return to 1.7% by the end of 2022 (up from 1% at the end of 2017). For context, the firm historically has produced average operating margins of 2%-2.4%.

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 the firm 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 that 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.