Owens & Minor Stock: Not So Minor Warning (NYSE:OMI)

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Just a couple of days ago, I concluded that Owens & Minor, Inc. (NYSE:OMI) was not looking so healthy in this article. While I have no intention to provide a full recap of that article here, I will quickly run through some major events in recent history to understand where the company is coming from, and what was the foundation of my cautious stance, before looking forward.

Some Background

Owens & Minor was a somewhat boring and predictable distribution business in the 2010s, but following the acquisition of Halyard Health’s surgical and infection business, leverage overhang has cast a real shadow on the prospects for the shares and profitability of the company.

The company found itself in dire straits ahead of the pandemic, with its shares trading in the mid-single digits, as the pandemic provided a lifeline for the business. The company has seen a huge growth in its distribution channel, allowing for a one-time boost in earnings, as the increase in the share count means that the company was able to raise some cash by selling shares at higher prices.

A company with dismal profitability and a $1.5 billion net debt load ahead of the pandemic ended up earning more than $2 per share that year, with net debt down to less than a billion, and further improvements seen in 2021, with earnings seen far beyond $3 per share.

In February of this year, 76 million shares still traded at $40, resulting in a $3.0 billion equity valuation, or $4.0 billion enterprise value if net debt of nearly a billion was included. This was applied to a business set to post some $10 billion in sales in 2021, with EBITDA seen around $475 million and earnings seen close to $4 per share.

Making The Same Mistake?

Early in the year, I was surprised to learn that the company reached a $1.6 billion deal to acquire Apria, resulting in a huge $2.5 billion pro forma net debt load. With just $1.2 billion in sales generated from home respiratory therapy and sleep apnea products, the deal was small in terms of sales, albeit that a $230 million EBITDA contribution revealed margins around 20%. Pro forma EBITDA would rise to nearly $700 million, for a 3.5 times leverage multiple.

Being fearful about such higher leverage ratios, certainly as the core business was seeing peak profits based on the pandemic, I wondered why the company would take on so much leverage after the same leverage nearly bankrupted the company two years ago. Moreover, a $3.00-$3.50 earnings per share guidance for 2022 revealed that momentum had peaked already. The company only hiked the earnings guidance by five pennies alongside the first quarter results, despite the Apria deal, which was not really impressive.

Second quarter sales were up just 0.4%, even as a strong dollar could explain some of the softness. Second quarter adjusted earnings fell twenty cents on a sequential basis to $0.76 per share, as the full year guidance is now seen at just $3.00 per share. That revealed a big cut in the guidance, calling for second half year earnings around $1.28 per share.

With EBITDA set to fall to $625 million, quite a bit lower than anticipated, and net debt actually inching up to $2.51 billion, leverage ratios were huge, as shares had fallen to $22 already last week. A normalization of volumes, higher interest rates and strong dollar all hurt the results. Even as a 7 times multiple looked too good to pass, a 4 times leverage ratio was very dangerous given the set of circumstances in my eyes, certainly given its history.

A Huge Warning

On the 12th of October, Owens & Minor announced an overhaul in its executive leadership, including a new CFO. That was just part of the story, as the company has cut the third quarter earnings guidance, based on adjusted earnings, with earnings now seen at $0.39-$0.41 per share. The company has furthermore cut the full-year guidance to a midpoint of $2.55 per share, which implies that fourth quarter earnings are seen around $0.43 per share. This is never a great story, certainly not if combined with executive turnover.

Moreover, EBITDA will fall to $532 million, as a $2.51 billion net debt load by the end of the second quarter results in a 4.7 times leverage ratio. Besides, the information given in the press release was quite limited, not providing a lot of information and leaving investors clueless about the state of the business, or actions taken to avoid leverage distress.

Following the announcement, shares have fallen to $15 per share, as a $7 move lower has cut the valuation by more than half a billion. Ironically, the current $1.1 billion equity valuation is far less than the purchase price of Apria at a $1.6 billion price earlier this year.

And Now?

Following the big profit warning, it is clear that Owens finds itself in real dire straits, with leverage concerns weighing on the investment story here. Given all of this and the recklessness of management, I am approaching the situation with great interest yet caution. Despite this, at some point in time, appeal should emerge.

Nonetheless, I am very skeptical of highly leveraged businesses in this interest rate environment, making me extremely cautious here, and despite the big pullback, I cannot commit myself to buying the dip just yet.

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