The Cooper Companies: Rating Upgrade As Near-Term Momentum Should Continue (NASDAQ:COO)

Overview

I previously rated a hold rating for The Cooper Companies (NASDAQ:COO), as I thought the valuation was too high back then, in July 2023. I believe my call was right, as the stock saw a sharp reversion back to its historical trading multiple of 19-22x forward PE, which led to a sharp reversion in share price from ~$100 to $75 in just 3 months. As COO ended FY23, I thought to give an update on the business and my outlook. My recommendation for COO is a buy rating with an expected return of 8% over a 6-month period (or ~16% on an annualized basis). My view is that the near-term demand outlook remains very strong and that COO has the right product fit to continue capturing growth. As topline expands, it should be able to improve its margin profile as well, recovering to FY22 levels. As such, while the 27x forward PE multiple is still high when compared to history, I see the possibility of it persisting at this level over the near term.

Recent results & updates

Total revenue for 1Q24 grew 8% constant currency [CC] to $932 million, split between CooperVision [CVI] sales of $621.5 million (7% organic growth) and CooperSurgical [CS] sales of $310 million. Total revenue beat the consensus estimate of $916 million. Down the P&L, a gross margin of 67.3% came in roughly 130bps above consensus due to efficiency in price across both CVI and CSI. Adj EPS also beat consensus estimates of $0.78. For FY24, management raised revenue guidance to $3.847 to 3.897 billion from a prior range of $3.809 to 3.877 billion, which implies an organic growth step up from 6 to 8% to 7 to 8%, a modest increase at the midpoint. EPS guidance was also adjusted upwards to $3.50–3.58 from $3.40–3.50.

COO really executed well and started FY24 with a bang, which has led me to believe there is a good chance for momentum to persist over the near term. Looking back, COO high-single-digit [HSD] to low-teens percentage growth in contact lenses has consistently outperformed (note management talked about market growth in the earnings calls; please refer to that as source), resulting in continued share capture, and I think this is a very strong testament to product fit and distribution capabilities. I expect COO to continue commanding strong leadership in products that have a high growth profile, such as toric and multifocal. Management discussed this deeply in the latest call, so I will not be repeating them, but I have quoted a few key statements that should be worth highlighting below. Hence, my view is that COO is well positioned to continue to deliver growth above the contact lens industry for the foreseeable future. Aside from product leadership, COO also has the myopia management segment. Despite the fact that this is still a tiny portion of the company and has been slow to take off, COO has gained exposure to a rapidly expanding and underserved market through MiSight and SightGlass. My view is that this basically expands COO addressable market, and with their track record of rolling out the right product, I am positive they can repeat the same success seen in other markets, and I think the recent results have been promising. Note that growth in 1Q24 could have been better if not for the shortfall in capacity for MyDay, which saw demand rapidly ramp up.

Demand for the product continues to be driven by our market-leading toric design, which mirrors Biofinity’s design and our industry-leading SKU range, which is by far the widest toric range in the daily market.

Outside of dailies, demand for Biofinity remained strong led by torics and multifocals. It’s worth highlighting our Biofinity toric multifocal which is growing very nicely as eye care practitioners continue making it their primary lens for patients experiencing more complex vision needs balancing Presbyopia with differing levels of astigmatism.

It’s going to continue to be strong because you’re continuing to get wearers that are going in, whether it’s a new wearer or an existing wearer, moving themselves to dailies and moving into torics and multifocals. From: 1Q2024 earnings call

As for the CS segment, I see this as a cash-generative segment that funds the core growing business, CVI. Comparing the segments, CVI had an EBITDA margin of ~16% in FY23, while CS had an EBITDA margin of ~28.5% (almost double). Management has also done a great job of reviving the revenue growth profile from ~5% to ~10% in FY23. While some of the growth has been driven by M&A, management FY24 guidance for 5 to 7% growth seems plausible given that 1Q24 grew 8% organically. I expect this segment to continue generating cash for COO to reinvest in the CVI segment.

All in all, I must say that COO has done a good job of delivering continued strength on the top line and, importantly, translating this to more consistency on the bottom line as well. Demand trends remain robust (according to 1Q24 earnings call) in contact lenses where the market itself is growing healthily, and COO has the right product fit in high-growth sub-segments that should enable it to continue growing at a similar pace. With an improved macro backdrop, I am optimistic that this growth in the near term could even see some acceleration, which could translate into upside EPS growth that supports the current premium valuation.

Our earnings were strong, and our momentum is excellent with capacity expansion progressing well and demand remaining very healthy. From 1Q24 earnings call

Valuation and risk

According to my model, at 27x forward PE, COO is valued at ~$110 in the near term, representing an 8% increase over a 6-month period (or about 16% on an annualized basis). This target price is based on my growth forecast of 8% in FY24 and 10% in FY25. My FY24 growth forecast is based on guidance, which I think is achievable based on the growth momentum seen in 1Q24 (8% organic growth) and the current demand outlook. With the improvement in the macro backdrop, I believe growth will accelerate in FY25 simply because of the overall improvement in consumer demand. Similarly, I forecasted margin expansion over FY24 and FY25. My assumption is that with almost 30% more revenue than FY22, COO should at least achieve margins above what it had achieved back then. Lastly, I understand that I mentioned that 27x forward PE was high previously, but given the strong demand outlook, a visible recovery in macro conditions ahead, and a short investment duration of ~6 months, I believe valuation could stay at this level for the near term.

Risk

Although I see justification for trading at this level, we have seen what might happen when the macro outlook turned negative (2023 July was when rates hit a peak of 5–5.25%). Although the Fed reinforced their view to cut rates by 3x this year (just last night), if they flipped on their words, COO valuation could see a big hit again. A company specific risk is that if myopia becomes a really serious issue. It is good for COO when myopia is fixable with contact lens or specs, however, if it is a serious myopia case, the patient may undergo surgery (ie Lasik) to improve its vision. In this case, the demand for COO will be impacted.

Summary

Summarizing this post, the recommendation for COO is buy rating. While COO was previously rated a hold due to high valuation, a strong start to FY24 with better-than-expected revenue and earnings has shifted my outlook. I expect COO to continue benefiting from robust demand in contact lenses, particularly high-growth segments like toric and multifocal lenses, and it should grow above market given its exposure in high growth sub-segments. Additionally, MiSight and SightGlass offer promising growth potential. Upside potential exists, especially if the macro environment continues to improve. The main risk is a potential valuation correction if the macro backdrop weakens or the Fed changes its monetary policy.