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Alcon: A Secular Grower

- By New Moon

Alcon Inc. (ALC) is a leading eye care company. Investors may be most familiar with its Opti- Free branded contact lens solution, but it also has exposure to the surgical area. The business is divided into two segments, surgical (about 55% of sales) and vision care (45% of sales). About 40% of sales are generated in the U.S.

The company's surgical business offers ophthalmic products for cataract surgery, vitreoretinal surgery, refractive laser surgery and glaucoma surgery. Its surgical portfolio includes implantables, consumables and surgical equipment required for these procedures and supports the end-to-end needs of ophthalmic surgeons. The company has number one market share in the ophthalmic surgical market.


The vision care business comprises daily disposable, reusable and color-enhancing contact lenses and a comprehensive portfolio of eye health products, including products for dry eye, contact lens care and ocular allergies, as well as ocular vitamins and redness relievers. Alcon has number two market share in the global vision care market.

Founded in 1945 in Forth Worth, Texas by two pharmacists, Nestle (NESN.SW) acquired Alcon in 1977. In 2002, it made 20% of the company public with a $2.3 billion initial public offering. Starting in 2008, the Swiss company gradually sold Alcon to Novartis (NVS).

On April 9, Novartis spun off the surgical and vision care part of the Alcon business, but retained its pharmaceutical business.

Why the stock is interesting

Eye care is a secular growth market

The global eye care market is growing at a 4% clip. It is no secret there are more eye problems as a result of increased usage of electronic devices and other factors. As a company with leading market share, Alcon is likely to grow its top line at a mid-single-digit rate.

Margin expansion and improving financials expected

Over the last 40 years, Alcon was first a consumer product conglomerate then was combined with a pharmaceutical company. The lack of autonomy may have contributed to its lower margins compared to peers.

Management guided for material margin improvement over the next five years, which looks like a very achievable target based on peers' margins.

Alcon's revenue should grow at the same rate as the industry. Based on management's guidance for margin expansion, the company's adjusted net income should grow at a compounded annual rate of 12% to 13% over the next five years.

A high return business with wide moat

I estimate Alcon's core business will generate a 20% return on invested capital. The company's financials, however, are clouded with a very large amount of intangibles. Return on invested capital is also low as $20 billion out of $27 billion in assets are intangibles and goodwill.

By inspecting the 2010 financial statement, I found Alcon's business is capital light with high returns. ROIC back then was 30%. While half the company was in pharmaceuticals at the time, Alcon now also has Novartis' eye care business. As a result, I am confident the company has a core ROIC above 20%. High ROIC reflects good quality of the underlying business.

Valuation

Alcon is cheap on an enterprise value-sales basis compared to its peers with similar business models and moats, but has lower margins. I expect it to be a less risky, long-term holding and would look to be more aggressive if the stock price is under $50.

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This article first appeared on GuruFocus.