Robust Valuation Leaves Neogen Little Room For Error After Mixed Results

 

Neogen (NEOG) has never traded in line with normal valuation metrics, and it may well never do so – or at least not over a reasonable investment horizon. The reality is that there’s scarcity value in the growth markets of food safety and animal safety, and investors have long been willing to pay up for exposure to these markets (you can see pretty robust multiples at others like IDEXX (IDXX) and Zoetis (ZTS) too). Still, I do believe that valuation matters, and these shares have lagged both the S&P and some of these food and animal safety peers this year (and since my last update).

Were I the sole owner of Neogen, I’d probably have few real concerns now, though the move towards larger M&A does carry some risk, and there’s a “predictable unpredictability” to demand-drivers like pathogen outbreaks (like aflatoxin outbreaks or the recent ASF outbreak). As a publicly-traded company, though, it’s a hard valuation call to make. About the best I can do is argue that, relative to the norms of the sector, Neogen’s valuation isn’t out of line, but this just doesn’t work for me as a GARP-type of investment candidate.

 

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Robust Valuation Leaves Neogen Little Room For Error After Mixed Results

Neogen Pressured On Trade Tensions, But Still Well-Loved

A lot of what you need to know about Neogen (NASDAQ:NEOG) can be summed up thusly - after a nearly 25% pullback from the 52-week on tariff-related headwinds, the shares still aren't even close to undervalued by any conventional valuation approach. As I've said in the past, Neogen shares live in their own world where valuation is concerned, as institutions (over 90% of the ownership base is institutional) seem to be valuation-insensitive when it comes to owning a pure-play on food safety and food/production animal care.

I don't think the headwinds that Neogen is seeing today are going to last indefinitely, and there are significant long-term growth opportunities in both genomic testing and in emerging markets like Brazil and India. I can't get comfortable with the valuation, but if the U.S. and China find a way to make peace on trade, these shares should regain some momentum in 2019.

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Neogen Pressured On Trade Tensions, But Still Well-Loved

3M Beats Lowered Expectations, But The Second Half Has Challenges

The wilder the party, the worse the hangover, and 3M (MMM) shares were definitely a major beneficiary of the Street’s overheated enthusiasm with industrials going into the start of this year. Still down a quarter from its peak, 3M is looking at a slow process of rebuilding expectations and investor trust, even though the company’s “disappointments” were really not all that egregious.

3M posted decent second-quarter results, with surprisingly strong pricing, but margin concerns will persist and the company is looking at some challenging growth comps in the second half of the year. Valuation is more reasonable now, but stocks like Honeywell (HON) and Eaton (ETN) appear to offer more value among the U.S.-centric multi-industrials.

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3M Beats Lowered Expectations, But The Second Half Has Challenges

Neogen's Story Continues To Work

Neogen (NEOG) is the sort of stock that could make value investors tear their hair out in frustration. No question that this is a very good company – basically a “one-stop shop” for food safety and food animal products, Neogen has produced mid-teens long-term revenue growth, 20%-plus free cash flow growth, and an annualized return of over 26% over the past decade, despite almost always sporting exceptionally robust valuation multiples and not hitting its own operating margin goals for five straight years.

Having followed this company for around 20 years, I no longer spend as much time trying to make sense of the valuation – Neogen lives in its own little “pocket dimension” of the market when it comes to valuation, and that either works for you or doesn’t. Fundamentally, though, the company continues to improve its food safety, animal care, and genomics offerings, and as more of the developing world adopts more rigorous food safety testing, I believe Neogen’s market opportunity should continue to grow.

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Neogen's Story Continues To Work

Seeking Alpha: Neogen Flexing Its Operational Excellence

If you want to argue that valuation doesn't matter, you could certainly do worse than to highlight Neogen (NASDAQ:NEOG) as a prime example. Seemingly always expensive, Neogen has nevertheless leveraged its proven model to generate mid-teens annualized revenue growth over the last decade and nearly 20% operating income growth. Then again, maybe valuation does matter - if you had bought in five years ago, you'd be sitting with a double, but that's true for IDEXX (NASDAQ:IDXX) too, and you would have done even better with Illumina (NASDAQ:ILMN), Thermo Fisher (NYSE:TMO), or MWI Veterinary Supply (NASDAQ:MWIV). Even 3M (NYSE:MMM) (and yes, we're really stretching the notion of comparable here) would have given you a 70% return before dividends over the past five years.

So, what to do about this stock? I love Neogen's business, and I think the company has a lot of room to grow with its allergen, toxin, and antibiotic tests, its food safety products, and its genetics/bioinformatics business. I also think the company's time-tested acquisition strategy can be applied again and again to grow the business, particularly outside the U.S.

But trees don't grow to the sky, and how much growth should investors expect? Growing revenue at a double-digit annualized rate for the next decade would be fantastic for most companies, but even a 20% 10-year FCF growth rate only gets you to about a $60 fair value in my model. My concern, then, is that Neogen can remain an operationally superb company but one whose share price performance could lag as those multiples start to come down.

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Neogen Flexing Its Operational Excellence

The Motley Fool: 3 Reasons to Like Zoetis

Wall Street is often willing to pay extra to sleep better at night, and Zoetis (NYSE: ZTS  ) is the sort of business that won't often lead investors to lose much sleep. The largest player in animal health, Zoetis is in the top three in every relevant sub-market it addresses and is often #1 or #2, but its leading product is less than 10% of sales and the top 10 list of products is less than 40% of revenue. Helping Zoetis' valuation even further is the relative lack of alternatives – companies like Neogen, Virbac, and Dechra are much, much smaller (and harder to own for larger funds), while the big comparables remain locked within large pharmaceutical companies like Merck (NYSE: MRK  ) , Sanofi (NYSE: SNY  ) , and Lilly (NYSE: LLY  ) .

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3 Reasons to Like Zoetis

Seeking Alpha: Neogen Priced Like The Excellent Company It Is

Following Neogen (NEOG) is frustrating, as there really isn't all that much to say from quarter to quarter. Neogen continues to acquire attractive niche businesses to augment its revenue and continues to build an appealing food safety business that goes from the farm to the factory. Neogen also continues to look shockingly expensive or, at a minimum, incorporates demanding expectations that few companies could hope to attain.

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Neogen Priced Like The Excellent Company It Is

Seeking Alpha: Gravity's Only A Theory With Neogen

Neogen (NEOG) is one of the more remarkable med-tech companies out there, but I'll bet it's all but unknown to a large swatch of the Seeking Alpha reading audience. This relatively small ($1.4 billion market cap) med-tech has grown its revenue by an average of 16% a year for the past 10 years, with the stock price rising almost 900% over that same stretch of time, and there could yet be ample room to the upside.

The problem is that Neogen always looks expensive and I just cannot get comfortable with the idea that the stock's multiples will always continue to defy gravity. While the company's record of organic growth, solid margins/ROIC, and accretive acquisitions would make this a very dangerous stock to short, I'd nevertheless need to see a substantial sell-off before wanting to buy it as anything more than a growth trade.

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Gravity's Only A Theory With Neogen

Investopedia: Neogen's Valuation Defies Gravity

While investors are often willing to pay high premiums for above-average growth, many companies see significant underperformance in their stock when they transition to a slower growth profile. That has not yet happened at Neogen (Nasdaq:NEOG). While it may indeed be premature to say that this food safety and animal health company is past its days of double-digit organic growth, the expectations that the Street has baked into this valuation seems difficult to justify.

A Sluggish Quarter, as Expected
To its credit, management didn't serve up any particular negative surprises this quarter. Revenue growth was sluggish at 6.3%, but broadly in line with expectations. Although there were some solid individual performances this quarter (veterinary products up about 30% and animal care up around 40%), it looked more as though the company saw a lot of individual items compress the growth - from de-stocking in Europe to tougher comps from vomitoxin sales last year and so on.

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Investopedia: Neogen Is Almost Cheap

Investors who want to play the really interesting stories in med-tech have to be ready to act fast or step up when times look uncommonly tough. That's about the only way to get a decent valuation on stocks like Intuitive Surgical (Nasdaq:ISRG), Cepheid (Nasdaq:CPHD) or Illumina (Nasdaq:ILMN), and that seems largely true for animal and food safety specialist Neogen (Nasdaq:NEOG). Although valuation and earnings quality are still problematic here, these shares also highlight the importance of being up-to-date on research and able to pull the trigger quickly.

A Disappointing Second Quarter  
Although Neogen doesn't generally step far out of line, this quarter was a notable exception. Revenue rose just 2% this quarter, not only missing the averaged estimate but missing the low-end estimate as well. Animal safety revenue was up just 1%, due at least in part to lower activity in the GeneSeek agricultural genomics business. Food safety was hardly stellar, though, as revenue was up just over 3% this quarter.

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http://stocks.investopedia.com/stock-analysis/2011/Neogen-Is-Almost-Cheap-NEOG-ILMN-BIO-LIFE-IDXX-WAT-SNY1229.aspx

Investopedia: VCA Antech Cut Down To Value

I have been writing about VCA Antech (Nasdaq:WOOF) for years, albeit not always on a consistent basis, and I clearly remember the baying, barking, and growling from longs when I used to question the company's valuation and business model. This was back when the stock traded in the $30s, mind you, and everyone believed that the veterinary practice roll-up model was bulletproof. Well, I wasn't short the stock then (nor am I now) and I wasn't being paid by hedge funds (nor am I now), but I was right - the business model couldn't support the valuation and investors who ignored the warning signs and hung on took a bruising. (To know more about stock valuation, check out: DCF Valuation: The Stock Market Sanity Check.)

Nowadays, though, it is a different story. I still do not believe that business models predicated on continual acquisitions can work (it's been tried over and over again in people-medicine), but the fact remains that VCA Antech now has a leverageable installed base and an undervalued cash flow stream.

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http://stocks.investopedia.com/stock-analysis/2011/VCA-Antech-Cut-Down-To-Value-WOOF-PETM-IDXX-MWIV1031.aspx

Neogen Is No Bad Egg

There seems to be a sad inevitability to food safety scares in the United States. While the latest outbreak revolved around contaminated chicken eggs, it has not been all that long since numerous people were sickened by bad peanut butter, jalapeno peppers, ground meat or scallions. In fact, the CDC estimates that one in four Americans experiences food poisoning every year (those "24-hour flu" cases are far more likely to be food poisoning). 

Given the huge potential consequences to a brand or business being associated with food poisoning, it may be surprising that food safety testing is not a larger business in the United States. Yet, it is big enough to make Neogen (Nasdaq:NEOG) an interesting business. 


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http://stocks.investopedia.com/stock-analysis/2010/Neogen-Is-No-Bad-Egg-NEOG-PFE-ABT-BIO-HSY-GPRO0928.aspx

Please note - a mistake was made in the editing process and an editor accidentally replaced Merck KGaA with Merck (MRK) as the owner of Millipore. I've pointed this out and it should be corrected shortly. 

Bringing Biotech To The Barnyard

Human genomics and genetic analysis gets a great deal of attention from investors and journalists. That attention is well-deserved, as a single cancer drug can be worth as much as $100,000 per year per patient. Clearly, that provides ample incentive for major drug companies to invest heavily in genomic equipment in the hopes of developing more effective drugs.


By no means is it just a pharmaceutical opportunity, either. Myriad Genetics (Nasdaq:MYGN) has built an attractive niche in gene-based cancer diagnostics, and larger players like Abbott Labs are also delving deep into molecular and genome-based diagnostics.

But why should people have all the fun? The cattle industry alone is worth about $80 billion a year in the United States, and there is clearly substantial money to be made in getting the best out of every Bessie and Wilbur in the feed lots.


You can read the full piece at: 
http://stocks.investopedia.com/stock-analysis/2010/Bringing-Biotech-To-The-Barnyard-MYGN-AFFX-ILMN-SQNM-TSN-WFMI-LMNX-NEOG0617.aspx