smartmoney chimed in yesterday:
June 17, 1998
DAILY SCREEN
When the Asia Crisis Fits Like a Glove
SAFESKIN
THE ONGOING crisis in Asia has already claimed plenty of victims as earnings season for the second quarter unfolds. But if you had a nickel for every company that has credited Asia's economic sickness for increases in earnings and gross margins, you'd have a hard time making change for a quarter.
Well, take a look at Safeskin (SFSK), a $195 million maker of latex gloves for medical examinations.
The San Diego company has massive exposure to the Pacific Rim, yet its gross margins jumped to 52% from 45% during the first quarter, helping earnings soar 47%. Even as Japan threatens to fall into depression, analysts are raising their 1998 and 1999 profit projections by 4% and 3%, respectively, landing Safeskin on our new earnings revision screen. (See recipe and screen results.)
The reason is simple: Safeskin manufactures its gloves and sources all of its raw materials in Thailand and Malaysia, where badly devalued currencies give exporters a big advantage both in terms of costs and prices. And with a dramatic increase in Thai production capacity planned for the next six months, the company has plenty of momentum. "Some people have accused us of starting the currency devaluation, but that's just not true," jokes Safeskin's CFO, David Morash.
Unfortunately, the Safeskin story is no big secret. The stock has nearly tripled over the last 12 months and has soared 27.1% year-to-date. At 36 1/16, it's 15.9% off of a 52-week high set in March, but it's still not cheap. Safeskin's price-to-book, price-to-sales, and price-to-cash flow ratios all far exceed industry averages. And its PEG ratio is on the expensive side at 1.35.
The question, of course, is whether the shares have any more room to grow. There's no easy answer -- especially given the market's extreme volatility. But there is a compelling argument going forward. It begins with earnings consistency: Thailand's abundant rubber and water resources had already made it an extremely profitable location for latex processing. And even before the currency devaluation, Safeskin had strung together six straight quarters of earnings surprises.
To keep growing, the stock will need a catalyst. It could come in the form of added capacity for even higher margin products. In 1997, the company had the capacity to produce 3.5 billion gloves. By the end of 1998, that number will be 5.5 billion and by 1999, 8 billion. "They're building fast and furious," says Melissa Wilmoth of Salomon Smith Barney. The need for more capacity has gotten so strong that the company's board recently voted to move 1999's capital expenditures into 1998 to keep up with demand.
Even more encouraging is that much of that capacity will be used to produce higher-end gloves. Safeskin, which already harvests better margins than its competitors, is in the middle of a product mix shift. The old standard in hospital examination wear was the powdered latex glove, which yields margins in the low-30% range. Those gloves still make up roughly half of acute care (hospital) sales, but they are rapidly being replaced by powder-free gloves. Hospital workers favor powder-free products because they are less likely to cause problems from continuous wear. Glove makers like them because they produce margins near 50%.
Safeskin developed the first powder-free glove in 1990 and still dominates the marketplace with a 47% market share. Although prices for these gloves have come down almost a third from their highs, demand is burgeoning. Some states have even introduced legislation to require powder-free gloves in hospitals and Safeskin, which boasts a 70/30 mix of powder-free to powder gloves, should be the prime beneficiary.
At the same time, the company is moving to build its share in synthetic, surgical and scientific gloves, all of which fetch margins upward of 50%. Safeskin has barely dented these areas, largely because it hasn't had the capacity. But with a new plant dedicated to producing these new products, that problem should disappear within a year. "Our product mix continues to improve as we go forward," says CFO Morash. "We've established ourselves as a high-margin producer on the low end [of glove types], and now we're moving up the margin scale."
Salomon's Wilmoth thinks Safeskin will be able to take advantage of its strong relationships with domestic distributors such as General Medical as it diversifies its portfolio of gloves. And, she adds, there are still several continents worth of opportunity for powder-free glove sales. "Eighty-seven percent of their product is sold in the U.S.," she says. "If they can create a market for their powder-free gloves in Europe, they could have another big burst of growth."
The risks for the stock are several: Any issue that has tripled in a year's time is vulnerable to a correction -- especially when it's trading at almost 30 times 1999 earnings. Small stocks are the industry's laggards. And there's always the chance that the price of rubber (which accounts for 30% to 40% of the company's cost of goods, according to one analyst) will rebound, having an immediate impact on profitability.
But given Safeskin's current lush profit margins, the promise of continued demand among health care professionals, and upcoming relief from capacity constraints, there's plenty to be said for the stock. After all, it doesn't look as if the Asia crisis is going to resolve itself any time soon.
-- By Joshua Albertson |
