Wednesday, May 5, 2010

Stock Idea: Emergent Group (LZR)

The company is Emergent Group (ticker: LZR), and it provides surgical equipment and technicians on a fee for service basis to hospitals and surgical centers. Their over 800 customers include small hospitals that can't afford to purchase the equipment outright as well as large hospitals that choose not to because of low utilization rates for certain procedures. The customer base of 800 is spread over 16 different states, and no one customer has represented more than 10% of total revenue.

Cash Machine

Revenue for the past year was about $31 million and has grown at a rate of over 20% over the last nine years (and even faster recently). More important in my opinion is the free cash flow that the company produces. It is an absolute cash cow because of its business model. While net income for the previous year was only $3.3 million, it produced $7.6 million in free cash. This discrepancy is largely due to the depreciation costs that it must incur on its equipment. The return on invested capital was huge this past year at 63%, which is even better than its already high five year average ROIC of 49%. Furthermore, Emergent has managed to increase this free cash flow by over 30% per annum over the last eight years (from the first year it had a positive free cash flow). It has used some of this cash to acquire two smaller medical device suppliers over the last three years, which I believe is a key component of its growth strategy. Last but not least, it throws off some of this cash in the form of a nice dividend (yield of 5.4%).

Managers Eat Their Own Cooking

This fantastic performance over the past decade is no accident. The management team is very experienced and also has a significant ownership stake in the company. The CEO, Bruce Haber, has been involved in the medical device supply industry for 29 years, the last seven of which were as the head of Emergent. The President and COO, Louis Buther, has been working in tandem with Haber in the industry for 27 years, including the last seven at Emergent. Haber owns 22% of the shares outstanding and Buther owns 11%, much of which has been accumulated over the past two years in the form of direct acquisitions, not option exercises. Not only do they appear to put their money where their mouth is, but they’ve backed it up with strong performances over the years.

Financial Health and Volatility

As far as the financial health of the company, I believe that it has a sound balance sheet. It has current assets of $13.3 million including $7.4 million of cash to cover $11.8 million in total liabilities. It has $2.7 in long term debt, which should be no problem considering the cash on hand as well as the cash flow it is capable of producing is plentiful. Despite being a small company and trading fairly thinly (only about 15,000 shares per day), Emergent has a beta of 0.65, so the price fluctuations are minimal.

Potential Headwinds

Of course, the big change to the medical device sector comes in the form of the new health care bill that has been passed. There is a new tax on medical equipment producers, however this may not apply to Emergent Group as it only purchases the equipment and then rents it out. The new law may in fact help Emergent in that 32 million more Americans will now be covered, meaning more surgical procedures will be needed. To be honest, I don’t really know the ramifications of the health care reform on Emergent. Since these are just guesses, I believe that the most uncertainty and risk lies with this issue. I also believe that as a small company, Emergent faces a lot of competition in a price-sensitive sector that probably has a lot of bigger players.

Cheap Valuation

While the company is too small to have growth projections and analyst followings, this also means that it is not well followed by Wall Street. As far as valuation, the company currently has a market cap of about $50 million, so while the P/E appears uninspiring at 16, it is trading at a mere seven times free cash flow. Even using a ridiculously high discount rate (15%) and a very conservative future projected growth rate (5%), the company still appears to be undervalued at its current price. I believe that there is a significant margin of safety to make up for the risks that the company faces.


As you can see, I really like this company, especially at its current price. While it has potential downside risk with regard to the future landscape of the health care industry as a whole, I think this risk is offset by its strong performance, dedicated management, and low valuation.


  1. Hey Eric, ive been following Emergent for about 6 months now and finally bought in. I too like it for the same reasons as you, FCF is excellent and they have a business model that seems to be working efficiently.

    Where did you find the information on them having 800 customers and no more than 10% at one of them?

    I realize this article was written a while ago so what do you think of their 2Q earnings report?

  2. From the most recent 10-K: "PRI Medical has approximately 800 active accounts in 16 states and experiences a high rate of repeat business from the hospitals, surgery centers and doctors we serve...Each location is staffed with full-time technicians and sales representatives, as appropriate to the business opportunities. During the years ended December 31, 2009 and 2008, no customer accounted for more than 10% of PRI Medical’s total revenues."

    As for your second question, I really try not to look too much into each quarterly earnings report. If I had to guess, I think it's probably just due to a faltering economy, and people are unsure about getting certain expensive medical procedures done. The fantastic growth rate couldn't be sustained forever without some bumps, and I think that the new lows present an even better buying opportunity. I still believe that the management is good, the balance sheet is sound, and the company is still making a hell of a lot of money.

    The only thing that concerns and confuses me is the selling before and following the earnings announcement, but I try to ignore the trading patterns and instead focus on capitalizing on such dips.