The Cooper Companies, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

The Cooper Companies is a global medical device company, specializing in contact lenses through CooperVision and medical devices for women’s health, through CooperSurgical.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

The Cooper Companies operates within the medical device industry, which is inherently more stable and defensible than many other sectors. However, it also requires consistent reinvestment and innovation to avoid technological obsolescence.

Business Overview

The Cooper Companies, Inc. operates through two main segments: CooperVision (CVI) and CooperSurgical (CSI).

CooperVision (CVI): This segment is focused on contact lenses, including daily disposables, multi-focal lenses, and toric lenses for astigmatism. This division generates the majority of the company’s revenue, at around 77% of overall revenue. CVI sells its products worldwide through a variety of distribution channels, including eye care professionals and retailers, with a heavy emphasis on the professional channel, which usually generates the highest margins. This segment focuses on premium products that cater to specific customer needs. Key markets include Europe, the Americas, and the Asia-Pacific region.

CooperSurgical (CSI): This segment concentrates on women’s healthcare products, including fertility solutions, devices for surgical procedures, and diagnostic equipment. This segment’s revenues account for around 23% of the company’s overall revenue and is focused on manufacturing high-quality specialized products that cater to the needs of the specialized medical professional community.

Notably, both segments operate in areas where consistent reinvestment in innovation is vital.

  • Contact Lenses (CVI): The contact lens market is characterized by high volume and price competition, as well as innovation to differentiate. Contact lens manufacturers tend to have a mix of branded and private-label products. The competitive landscape is dominated by a few large players: Johnson & Johnson, Alcon, and Bausch + Lomb. These companies tend to focus on creating innovative products and a focus on distribution and partnerships with eye care professionals and retailers.
  • Women’s Health (CSI): The women’s health market is highly fragmented, especially regarding the distribution of the product. A large part of the business comes from sales generated via direct sales and distribution to hospitals and clinics. This market segment is characterized by the strong growth of high technology solutions and high margin procedures. There has been a push toward new minimally-invasive surgeries. The market is more fragmented with a large amount of small competitors focused on a sub-segment of the market.

Competitive Moat Rating: 3 / 5

Although The Cooper Companies have some competitive advantages, they lack a robust wide moat. Instead, they appear to be in the narrow moat territory. Here is the justification:

  • Brand Recognition and Customer Loyalty: CooperVision has built up strong brand recognition with its premium lenses among eye-care professionals, which gives it some pricing power with those doctors. Once doctors tend to recommend a specific type of lens, they become stickier, creating a sort of customer lock in. This is particularly true in the higher-end specialty contact lens segment. This provides a narrow moat.
  • Innovation and Product Quality: Both CooperVision and CooperSurgical rely on a steady stream of innovation. The company invests significantly in research and development to create new products or enhance existing ones. Specifically, the company aims to focus on the highest quality specialty products, a strategy that is useful in the medical sector, where the quality of medical instruments can greatly affect the outcome of a procedure. A good reputation for quality can be a meaningful competitive advantage. This is very beneficial and creates a narrow moat.
  • Distribution Network: CooperSurgical, specifically, benefits from a strong and established distribution network, which allows the company to maintain pricing power with its products. These relationships can make it more difficult for competitors to gain ground in the market and create a kind of moat. However, it is not an unbreakable advantage, because there are many independent players that also operate in distribution. This creates a narrow moat.
  • Switching Costs Some of CooperVision’s custom-fitted lenses and custom made product lines do create switching costs that could make patients more hesitant to change their lens manufacturer or doctor, but the switching costs for the consumer is still low and not as sticky as software or financial products.
  • Scale: Economies of scale are a factor, especially on the CVI side of the business, but Cooper does not have as big an advantage as some of its other, larger competitors like Johnson & Johnson and Alcon. Scale advantages mainly appear in the CVI business.
  • Overall: There are limited to no network effects. Even the products are not so proprietary or innovative that others can not copy. The business does have some sustainable competitive advantages. The switching costs are not very high and there are a lot of competitors in both spaces of the business, and because of that, I’d give the business a moat rating of 3/5, which implies a narrow moat.

Moat Risks and Resilience

The economic moat is not unbreachable; there are many risks that could undermine the business resilience and competitive advantages:

  • Technological Disruption: The medical device industry is particularly sensitive to technological changes and the introduction of new treatments and technologies. For CVI, for example, competitors could come up with better performing contact lenses, and for CSI a more innovative product may overtake the incumbent’s product. These changes can quickly diminish the existing moats of the business.
  • Generic Competition and Price Erosion: The pharmaceutical space within CSI is highly sensitive to generics, or to the introduction of off-patent products that are similar to the market leader but with lower prices. Any development that results in substitutes or lowers the cost of production can destroy or significantly hurt the competitive advantage of the business.
  • Regulatory Changes: The medical device and healthcare industries are subject to intense regulations across the world. Changes in regulations can quickly impact approval times or the viability of a business, therefore making those businesses less attractive.
  • Brand Dilution: Brands are important for companies to keep their premiums, but the strength of the brands needs to be maintained. If brands do not innovate or change in line with consumer preferences, they may lose relevance.
  • Acquisition Integration: A large portion of growth at COO is achieved through acquisitions. Failure to integrate a business can lead to lower performance of the parent entity. Further, bad acquisitions can cause a company to overextend and be stretched thin.
  • Macroeconomic Headwinds: Economic downturns and high inflation could harm the demand for medical products and procedures or could hurt profitability. This is a significant concern, as we have seen that the health sector is highly sensitive to changes in the economic situation.
  • Competitive Overlap: Because they have many competitors, the company will need to be highly effective in implementing its strategies. Any shortcoming can result in market share loss, and a subsequent loss in pricing power.

The resilience of The Cooper Companies lies mainly in its continued commitment to innovation, its quality products, established distribution networks, and high levels of expertise, which can make it easier for them to adapt to a constantly changing landscape.

Detailed Financial Analysis

A deep analysis of the financials can provide key insight into business operations and sustainability. Here are the key elements:

Revenue Growth: The company has seen growth in recent years with the overall top line of revenue growing by around 7-8% year over year. That growth is mostly driven by the growth in revenue in the CVI segment, as the CSI segment has lagged behind. However, revenue growth has begun to slow down in more recent years. This should be monitored closely. Note that much of CVI’s growth comes from innovative product lines.

Profitability: Gross margins average around 60%. Operating margins averaged around 20% in 2023. Operating margins in 2023, were at their lowest levels since 2017, but are likely temporary and a result of higher input costs, inventory write downs and increased operational expenses.

Return on Invested Capital (ROIC): The company’s ROIC is lower at 8.7% if goodwill is included, but is at 12.2% if it is excluded, which reflects that a considerable amount of value of acquisitions has not translated to underlying profitability. However, these returns are not particularly strong and are more similar to their competitors’ ROIC.

  • Return on Equity (ROE): ROE is at around 10.7%, which is low for a company with such high levels of intangible assets and goodwill on their balance sheets. The higher return on equity has come from higher leverage in the capital structure, and the growth of revenues and net income.

Both ROIC and ROE values indicate there is no exceptional ability to generate wealth relative to their equity and assets.

Debt and Capital Structure: Total debt stands at around $4 billion while cash stands at $270 million. This amount of debt is manageable for a company of this size, and the company seems to be able to refinance its debt regularly. However, they have low amounts of equity compared to their debt. The company has a debt-to-equity ratio of approximately 1.2 to 1, and the target ratio seems to stay between 1.0 and 1.2.

This shows the company uses a lot of financial leverage to grow their earnings.

Free Cash Flow: The company has a free cash flow yield of around 6-7%, which is acceptable. The free cash flow is enough to cover debt servicing costs, acquisitions and share repurchases. These have been important drivers of value creation for the company in the recent past. It is important to monitor to see that cash flow remains positive and does not shrink.

The company is actively buying back its shares.

Goodwill and Intangible Assets: A lot of the value of the company is in intangible assets, including goodwill. Given this, it is important to consider the quality of the acquisitions and the possibility of impairment.

Acquisitions: As noted, the company has expanded its business through a series of acquisitions. These are always risky, and the company must be able to integrate the newly acquired businesses effectively to maintain growth and profitability. The latest acquisition, that of Cook Medical, will be very important for the future growth of the business.

As noted earlier, due to recent acquisitions, goodwill and intangibles are a large portion of overall assets and should be closely monitored.

Recent Concerns and Management’s Response: The company’s stock prices have experienced considerable volatility in the recent past. There has been some pressure on margins, due to inflation and increased raw material prices. There has also been concern regarding the ability of the company to continue its growth trajectory. Management stated they intend to focus on profitability and margins in the near future, rather than pursue growth at any cost. A key focus for the future is the integration of the latest acquisition (Cook Medical), and the ability to successfully integrate the business while continuing strong revenue growth is paramount to future performance. Management has stated that the cost side of the business will take time to improve, due to continuing problems with supply chains.

The company has started to lower debt over the last several quarters, something that is a very good sign.

Understandability Rating: 2 / 5

The Cooper Companies, Inc. has a complexity rating of 2/5, because it is not a straightforward business. Although the overall goal of the company, to produce and sell medical devices, is relatively easy to comprehend, several layers of complexity are added that require significant effort to understand.

  • Regulatory Landscape: The health sector is sensitive to regulations that may change at a moments notice, and a deep understanding of the rules for each market is essential for understanding the business.
  • Accounting Nuances: Revenue recognition, asset valuation, and amortization calculations are important for understanding the business, and require an investor to have some level of financial and accounting literacy.
  • Acquisitions: The company regularly acquires other businesses. Following the performance, integration of these businesses and any impairments that may occur are necessary for truly understanding the long-term value creation and viability of this business.

Balance Sheet Health Rating: 4 / 5

The company’s balance sheet is relatively healthy and gets a rating of 4/5.

  • Debt: Debt levels relative to equity are high, but manageable for a company of this size. They are actively reducing the debt, which is a positive sign.
  • Cash: The company has low amounts of cash relative to its debt, but free cash flow can cover interest expense easily.
  • Assets: Assets are well balanced with goodwill accounting for a considerable share. Property, Plant, and equipment is around one-fifth of all assets. Receivables, although significant, are also acceptable and relatively healthy.
  • Share Repurchases: The company is engaging in a significant share repurchase program. This can result in an added increase of debt, that management needs to keep an eye on.

Summary

The Cooper Companies, Inc. has a stable business with a narrow moat, mostly stemming from brand recognition, customer lock-in and a distribution network. The business model is relatively easy to understand, and the financials, while complex, are relatively easy to follow once all the terms are well understood. Its debt is a cause for minor concern, and the goodwill that is on the books due to acquisitions should also be monitored closely. Overall, the company has a relatively healthy business, but its future prospects are going to depend on the company’s ability to improve margins, maintain sales growth and successfully integrate recent acquisitions.