Alcon: Revisiting Investment Thesis (ALC)
Alcon Inc. (NYSE:ALC) recently published Q1 FY22 results which came in better than expected. The company maintains a double-digit revenue growth rate and is well on track to achieve its full-year guidance. Both segments – Surgical and Vision Care – posted solid growth and are well-positioned to increase shareholders’ value over the next quarters. Despite the positive results, I have lowered my fair value estimate from $76 to $59 per share. The main reason behind this adjustment is an increase in ALC’s discount rate from ~6% to ~7%, in line with the company’s updated WACC. All in all, I still believe ALC is a high-quality business with a durable moat.
ALC reported Q1 FY22 results on May 10th, 2022. Overall, the results were solid and exceeded Wall Street’s expectations. Sales reached ~$2.19 billion in the last quarter, representing a ~13.5% YoY increase, while the core operating margin increased from 18% a year ago to 20.6%. The solid results were mainly driven by ALC’s product mix, resilient supply chain management, and the continued recovery in markets previously affected by the COVID-19 pandemic.
The company generated 58% of sales from the Surgical segment and 42% from Vision Care. The product mix is similar to what the company posted in past quarters, although it is now slightly tilted towards the surgical segment. Both segments experienced double-digit growth in Q1 FY22 and benefit from a strong demand following the COVID-19 pandemic.
Surgical sales grew 17% YoY, driven by strong momentum in implantables. This sub-segment alone grew by 32%, making it the best performing product category of the company YTD. ALC remains a leader in presbyopia-correcting IOLs as illustrated by the strong demand for Vivity.
The Vision Care segment grew by 10% YoY (14% in CC) and is about to reach $1 billion in quarterly sales. Demand for ALC’s contact lenses continues to be strong, driven by existing successful products and the rollout of the Dailies Total1 for Astigmatism in the US and Total30 lenses in the US and Europe.
All in all, ALC delivered another good quarter. The guidance provided by management shows they remain optimistic about FY22, despite emerging fears of a global economic slowdown.
Speaking of recession fears, many investors have recently been disappointed by the returns generated by high multiple stocks, and we are now witnessing de-risking in equity markets. Healthcare is among the top beneficiaries of outflows from tech stocks, which means that companies like ALC stand to benefit from this sentiment shift in the short term.
In my previous article on ALC, I have come up with an intrinsic value of $76 per share. We are now slightly below my previous estimate since ALC trades at $74 per share. Based on 494 million shares outstanding, the company has a market cap of approximately $36.56 billion. In this part, I have updated my DCF model to reflect some of my latest assumptions:
- Estimated free cash flow for FY22 of $1.1 billion based on Wall Street estimates – unchanged.
- A growth rate of 13% until FY25 – ~200 basis points lower which reflects a more conservative value relative to estimated revenue growth.
- A 2% terminal growth rate – unchanged.
- A 7% discount rate – 100 basis points higher than in my previous article. The discount rate is in line with ALC’s WACC.
Based on my updated model, the fair value of the stock is around $59 per share, much lower than my previous estimate. I personally feel comfortable with this updated valuation as I believe it provides a higher margin of safety. At $59 per share, the company trades at approximately 24x forward earnings, which is definitely not cheap in a rising rate environment. I think it is important for investors to be cautious given the uncertainties surrounding inflation and ultimately interest rates. Rising rates will have a negative impact on ALC’s discount rate, and probably on its stock price.
Alcon continues to grow at a double-digit rate and is on track to meet management’s full-year guidance. Both the Surgical and the Vision Care segments delivered double-digit growth, which highlights a solid demand for the company’s products in every category. On top of the organic growth, management proved in the past they can speed up growth and enhance profitability anytime they are able to find attractive M&A targets. While I believe ALC is a buy-and-hold type of investment, I think valuation is increasingly important in a rising rate environment. The stock isn’t cheap despite the recent pullback, trading at more than 30x FY22 core diluted EPS, which leaves plenty of room for a move to the downside. Lastly, I have adjusted my valuation to reflect a higher discount rate, which has lowered my intrinsic value estimate from $76 to $59 per share.