Cooper Companies: The Inflation Opportunist


The Cooper Companies reported Q2 results on Friday last week. Despite market share gains across Cooper's core verticals, all-time record quarterly revenues (with 25% growth in CooperVision and 58% growth in Cooper Surgical) and interesting developments in new product lines that capture a very attractive long-term opportunity in Myopia (short-sightedness), the market seemed to ignore Cooper's results and miss what I believe to be a pivotal indicator in the near-term success for the business.




Background and Vision Business Overview


To give a brief background of the business, The Cooper Companies is a US-based global provider of vision care products through its CooperVision subsidiary. Founded in the 1950s, Cooper Companies entered the contact lens market in 1972 through an acquisition of a British company Global Vision. Cooper Companies has had multiple business units over the years, including a pharmaceutical segment. However, the business now relates to two specific units, CooperVision and CooperSurgical. CooperVision's 2020 revenues totalled $1.84 billion, equivalent to 76% of total revenue.


Focusing on CooperVision, the largest business segment for the group is solely based on one product line — contact lenses. CooperVision holds a market share at roughly 25% of the soft contact lens market. This is on a par with Alcon and behind market leader JNJ with the Acuvue brand. CooperVision manufactures lenses for general near/short-sightedness and other particular conditions such as myopia and astigmatism.


CooperVision sales generally split into three segments via the lenses they sell:

  • Sphere lenses, which contribute 57% of revenues and correct more simple sight issues;

  • Toric lenses, which contribute 32% of revenues;

  • Multifocal lenses, which contribute 11% of revenues and are solutions that are specifically tailored to more complex eye conditions.


Why is the contact lens industry attractive for investors?


The problem of sight difficulty across various conditions can be resolved via three main methods, two of which are generally poor investment ideas, and the other, which makes for a fantastic investor proposition. The three methods are generally: eyeglasses, eye surgery and, lastly, contact lenses. The reason contact lenses make for an attractive investment proposition is that their sales are repeatable in nature. The vast majority of prescribed lenses are for daily use, therefore, the end-user has to replace them very frequently leading to repeat business for manufacturers. Besides this focal point for investors, other qualities of this industry can be sourced from:

  • An oligopoly structure between four manufacturers — CooperVision, Alcon, Johnson and Johnson and Bausch + Lomb;

  • Low manufacturing cost/unit costs post R&D (which delivers a big barrier to entry);

  • Well engrained distribution channels through eyecare retailers;

  • Underlying trends such as Myopia (discussed later in this article), an ageing population and earlier use of contact lenses;

  • A highly regulated industry with a complex development process.


The Pivotal Indicator


Listening to the Q2 earnings call for Cooper Companies, a very smartly worded question from Stifel analyst Jon Block highlighted the key reason Cooper Companies has my attention over the coming months as we potentially move to a more inflationary environment. To directly quote the earnings call transcript:

Jon Block (Stifel analyst): "But, in the supposed inflationary environment, is there more of an opportunity this year for price for you guys to take that? And, Brian, while I'm going down that same road, for you, are there any material costs to call out in your opinion, putting pressure on the supply chain or other areas of the business?"
Al White (CEO): Yeah. On pricing, I would say yes, we've seen pricing trending higher. As a matter of fact, we've just heard some stuff, which I haven't confirmed, and it sounds like one of our competitors just recently took list pricing up a little bit. But you have seen list pricing moving up a little bit [already]. You've seen some rebate activity come down a little bit. I think, when you look at the world that we're in today, right, with some of the inflationary pressures that we see out there, there's probably a little bit more ability to take price than there has been certainly over the last several years.
Brian Andrews (CFO): Hey, Jon, I'll take the other question. Nothing really to point to. We've got long-term contracts with our suppliers. So nothing to highlight really right now on inflationary sort of raw materials or other costs.

So what does the above discussion actually mean?


Regarding the question from Jon, the Stifel analyst, he asks Cooper Companies whether they will be able to pass inflationary costs on to their customers in the form of price rises. After this, Jon asks the important question of whether Cooper is actually seeing any price increases themselves across their cost base. The response from Cooper Companies CEO Al White essentially explains that Cooper is in a very good position to increase prices, as the inflationary environment across the board in all industries gives Cooper room to justify price increases with their customers. However, the comments from CFO Brian Andrews state that, as a business themselves, Cooper aren't going to see any inflation across their cost base.


This is likely because the costs involved in producing contact lenses are typically weighted to R&D. After all, a contact lens requires only a tiny amount of plastic. Most of the value Cooper Companies creates is intangible, and thus Cooper is able to use this economic environment to its advantage and sneak in price rises.


The Myopia Opportunity


The market for vision care products and services is underpinned by long-term growth trends that have been present for the last decade and which will continue to prevail. The core trend in vision care is the ageing population; as humans live longer, our critical organs — such as our eyes — have a high likelihood of experiencing an age-related condition such as nearsightedness (myopia), astigmatisms, cataracts and glaucoma. The World Health Organisation suggests that by 2050 over 2 billion people will be over 60, and this ageing population will lead to an estimated 4% growth in vision care end markets over the medium term.



Source: World Health Organisation


A key trend, which is not just related to our ageing population, will be the presence of Myopia. Myopia is the condition of near-sightedness that is set to increase as human activity becomes more digitally orientated with humans spending less time outdoors. Studies have suggested that over half the world’s population will have some form of Myopia by 2050, and much of this will require corrective lenses.


CooperVision actually has the broadest portfolio of lenses in the Myopia category and the Q2 earnings call described many product developments that will capture growth in the overall market.


A Brief Summary of Cooper Companies' Q2 Results

  • Revenue of $719.5 million — up 37% from last year’s second quarter and up 32% in constant currency.

  • Gross margin of 68% compared with 62% in last year’s second quarter.

  • Operating margin of 20% compared with 5% in last year’s second quarter.

  • Interest expense of $6.1 million compared with $12.8 million in last year's second quarter driven by lower interest rates and lower average debt levels.

  • Net debt outstanding at quarter end was $1,631.6 million (total debt of $1,737.5 million less quarter-end cash and cash equivalents of $105.9 million). Adjusted leverage ratio (net debt over adjusted EBITDA) of 1.78x.

  • Cash provided by operations of $192.6 million offset by capital expenditures of $49.9 million resulted in free cash flow of $142.7 million.


Cooper Companies' Five-Year Financials


Source: Twenties Trader March Newsletter, Cooper Companies Annual Reports


Looking at the above financial table I recently created for my March newsletter, prior to the pandemic, Cooper Companies had been growing at a pretty decent rate. 2020 brought this growth to a halt, but considering the damage the pandemic caused to other businesses in healthcare and medical devices, the -8.4% result was pretty resilient and testament to the stickiness of the contact lens business. Gross and operating margins are both pretty solid, and the Q2 earnings call alluded to more margin improvement in the coming quarters as Cooper Companies starts to grow scale in the surgical business unit and leverage their fixed cost base.


Summary


I very much like the resilience of Cooper Companies' business model and the long term opportunity CooperVision has with key trends such as the Myopia epidemic and the general ageing population. Also, in the short term, any inflation worries (as alluded to in their recent earnings call) can be succinctly avoided with the ability for Cooper Companies to raise prices, whilst not being affected by rising costs across its supply chain.


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