1

Owens & Minor Analysis

By Steve Schudin

April, 2014

Introduction

2

Owens & Minor Inc., whose ticker symbol is OMI, is a distributor of medical and

surgical supplies as well as an industry leader in supply-chain management especially for the

healthcare industry. The company was founded in 1882 and is headquartered in Mechanicsville,

Virginia which is in the Richmond area.

According to Yahoo Finance, Owens & Minor has three main competitors. Cardinal

Health and McKesson Corporation are both publically traded. Medline Products is the one

private company that competes with Owens & Minor in the medical and surgical supplies field.

Owens & Minor’s strength was recognized several months ago in September of 2013

when Standard & Poor’s upgraded its credit rating from BB+ to BBB- and gave the company an

outlook of ‘stable’. Jordan Grant of Standard & Poor’s Health Care Group was quoted as saying,

“The upgrade reflects Standard & Poor's increased confidence in the company's ability to

compete against larger players in its markets and maintain financial conservatism.”

My analysis was primarily based on a five-year study of OMI’s annual reports covering

the reporting periods from 2009 through 2013.

Profitability

The two primary measures of profitability, return on assets and return on owner’s equity,

can vary a great deal across industries. The only way to determine if the percentages are good or

bad is by comparing them to the same figures for a company’s competitors, or at least by

comparing figures for companies that are within the same industry. One thing that can be done

with the profitability ratios of a single company is to look at their general year-to-year

movement. Ideally they should both be moving upward.

3

Unfortunately both the return on assets and return on owner’s equity for Owens & Minor

have been moving downward. For the return on assets there was a slight upward tick from 2009

to 2010, since then it has been down steadily. For the return on equity, the downward trend has

been consistent each year from 2009 through 2013.

Here is the five-year performance for both ratios:

Return on Assets Return on Owner’s Equity

2009 6.0% 14.35%

2010 6.1% 13.60%

2011 5.9% 12.97%

2012 4.9% 11.52%

2013 4.8% 11.10%

Liquidity and Cash Flow

The company’s current ratio, while always well above 1, has actually been in decline

during the 2009 to 2013 period. The fact that the current ratio is always above 1 indicates that

the company should always be able to meet its short-term obligations, but again the movement

trend is what draws attention and invites some concern. The current ratio for 2013 was 1.74;

which most people would call very respectable. In 2011 however the current ratio was 2.09,

which was the highest of our five studied years. For the first year of the study, 2009, the current

ratio was 1.92. For the entire 2009 through 2013 period, the average current ratio was 1.91.

4

There are many companies out there that would love to have Owens & Minors most

recent current ratio of 1.74. Consider though that from 2009 through 2011, the current ratio

increased almost 9%. Then from 2011 through 2013, the current ratio reversed its direction and

fell over 19%. The most recent current ratio is the lowest that it has been during the five years

studied and, in the event of a stock purchase, would need to be continuously monitored for future

movements.

The five-year movement of the current ratio is as follows:

Ratio Percentage Change From Previous Year

2009 1.92 -2%

2010 2.06 7%

2011 2.08 1%

2012 1.76 -15%

2013 1.74 -1%

The balance sheet showed a strong consistency for the five years studied. From 2009

through 2013, total liabilities stayed between 53% and 56% of assets. Correspondingly,

shareholder’s equity stayed between 44% and 47% for the same periods. The only possible

reason for concern is the recent direction of movement. In a move that is very similar to the

current ratio, equity-to-assets rose from 44% in 2009 to 47% in 2011 for an increase of 7%.

From 2011 to 2013, it reversed direction and retreated back to 44%, giving up exactly the 7% of

equity previously gained and with a corresponding increase in liabilities.

5

One item of concern within the current assets is the cash itself. In 2009, cash represented

7.2% of current assets. The following year cash peaked at 11.1% of current assets. That was an

increase of slightly over 55% in one year! Unfortunately from 2011 through 2013 there has been

a consistent decline in cash as a percentage of current assets.

Starting in 2011, cash as a percentage of current assets dropped from the previous years’

high of 11.1% to 8.9% for a retreat of about 20%. In 2012 and 2013, cash as a percentage of

current assets continued to decline to 6.0% and 5.9% respectively. From the 2011 high, cash as a

percentage of current assets has actually fallen approximately 47%. This is a three-year decline

that cannot be ignored.

Free-cash flow per share did rise in 2013, but only after a previous year where free cash

flow was at a 5-year low due to a large acquisition. For the five years studied, free cash flow

was at its highest, both in total dollars and per-share, in 2009. From there free cash flow fell for

two years in a row without any obvious reason like an acquisition.

In 2010 Owens & Minor did a 3-for-2 stock split. This means that all free cash flow per-

share figures for years after 2009 would be much lower due to the free cash flow being divided

among many more shares. For this reason, I have created a table of OMI’s free cash flow

performance for the five years studied with the dollar amounts divided by the 2009 shares

outstanding, in order to provide an apples-to-apples comparison between years.

Free Cash Flow 2009 Shares Outstanding Per-Share % Change

2009 $196.823M 41,959,865 $4.69

6

2010 $105.760M 41,959,865 $2.52 -46%

2011 $34.534M 41,959,865 $0.82 -67%

2012 $27.631M 41,959,865 $0.66 -20%

2013 $83.476M 41,959,865 $1.99 202%

Naturally the 202% gain in 2013 is not expected to be sustainable. It was only because

the free cash flow in 2012 was so low due to a European acquisition, which will be explained in

the investment section. What is more concerning is that for two years before the acquisition, free

cash flow still fell dramatically. This would have to be considered a serious ‘red flag’ for a

prospective investor.

Debt and Other Liabilities

The liabilities side of Owens & Minors balance sheet did not contain anything alarming.

In the profitability section above, we mentioned that Owens & Minor had an increase in total

equity to total assets of 44% in 2009 to 47% in 2011 for a gain of 7%. It then did an about face

and went from 47% in 2011 back to 44% in 2013, giving up that 7% gain. This movement

corresponds with total liabilities in that in 2009 total liabilities represented 56% of assets on the

balance sheet. By 2011 liabilities had dropped to 53% of assets, but then rose again to 56% by

2013, reflecting the corresponding drop in total equity. Clearly OMI was taking on more debt in

its operations during this time, though nothing too extreme.

Accounts payable did go up in every year except one for the period 2009-2013, but then

so did revenues. A growing accounts payable is not a bad thing by itself, but it should be

coupled with a growing accounts receivable in the assets section of the balance sheet, and both

7

should be reflective of a growing revenues figure at the top of the income statement. The three

numbers together simply reflect an increase in business overall.

Since accounts payable is a function of ongoing business, we did a comparison between it

and gross revenues and found that it was very steady from 2009 through 2012 and only showed a

bit of weakness in 2013 when it rose above 7% of revenues. This gradual increase in AP as a

percentage of revenues since 2011 also lines up with the decrease in the current ratio discussed

above.

Revenues Accounts Payable Percentage

2009 $8,037,624 $546,989 6.8%

2010 $8,123,608 $531,735 6.5%

2011 $8,627,912 $575,793 6.7%

2012 $8,868,324 $603,137 6.8%

2013 $9,071,532 $643,872 7.1%

The only drastic increase in liabilities is explainable. From 2009 through 2011, long-

term liabilities only increased 2%, from $208.4 million in 2009 to $212.7 million in 2011. Then

in 2012 long-term liabilities took the proverbial quantum leap to $925.6 million. This increase

lines up with the purchase of Movianto and Owens & Minors entry into the European markets.

The fact that the increase in debt can be explained with a major purchase of another company

means that there is no immediate need to be concerned.

8

The Movianto acquisition will be explained in further detail in the next section. There

were no other movements in Owens & Minors liabilities that appeared unusual.

Investments

Owens & Minor is not a company that consistently invests in the securities of other

companies or in the municipal bond market. In its 2009 statement of cash flows, a gain of almost

$7 million was booked as ‘net cash received related to acquisitions of businesses’ under its

investing activities. Owens & Minor then went on to post $0 for this same line item in both 2010

and 2011.

This changed in August 2012 when Owens & Minor acquired a European firm by the

name of Movianto for $155.2 million. According to Owens & Minors 2012 annual report, the

Movianto acquisition not only introduces OMI to the European healthcare market, but it also

takes OMI beyond its core business of medical and surgical supplies and brings the company

into the areas of medical devices and pharmaceutical distribution.

The Movianto acquisition brought a permanent change in OMI’s reporting in that for the

first time it had to segment its financial data. Movianto is now listed in Owens & Minors reports

as the ‘International Segment’ while Owens & Minor itself is listed as the ‘Domestic Segment’.

This change began in early 2013 with the 2012 annual report.

For 2012, the international segment reported an operating loss of $5.4 million. In 2013,

the first full-year that Movianto was owned by OMI, the international segment did show an

improvement but still reported a loss of $1.4 million. Owens & Minor did note in the 2013

report that Movianto’s performance did show improvement in the second half of 2013.

9

Pensions and Other Postretirement Benefits

Owens & Minor has not had any entries for pension expense on its income statement or

pension contributions on its statement of cash flows since 2010. The reason for this can be found

on page 16 of the company’s 2010 annual report. A footnote at the bottom of the page reads,

“We terminated our frozen defined benefit pension plan in the fourth quarter of 2010 and

recognized a settlement charge of $19.6 million ($11.9 million after taxes, or $0.19 per common

share).”

Growth Plans

Looking at the balance sheet purely from a growth point-of-view, Owens & Minor shows

an excellent consistency at growing its current assets from year-to-year, so it is likely that the

company does a good job of finding new business while retaining its current clients and

accounts.

In 2009 the company only grew its current assets by 2.3%. For each year after that

however the annual growth rate of current assets was always around 6%. The high for the

studied period was 6.8% in 2012. Unfortunately the most recent figure for 2013 was a retreat

from the previous year and came in at 5.9%.

Although the most recent year was a retreat, the annual growth in current assets is still

very respectable. For the total period of 2009 through 2013, the average annual growth rate of

current assets is 5.7%. This figure is drug down considerably by 2009, which was below the

following four years enough to be seen as an anomaly. If 2009 is removed from the calculation,

then the average annual rate of growth for current assets from 2010 through 2013 rises to 6.5%.

10

Moving to the earnings report, Owens & Minor has done a very impressive job of

growing its revenues year after year without fail. From $8.03 billion in 2009 to $9.07 billion in

2013, this represents a five-year growth in revenues of 13% total and with remarkable year-to-

year consistency.

Further, it seems that in this past year Owens & Minor has been doing a better job of

controlling their cost of goods sold. During the years 2009 through 2012, the gross margin

accounted for 9.9% to 10.4% of revenues, with the four-year average being 10.1%. Then in

2013, the gross margin suddenly jumped to 12.3% of revenues. This represented an increase

from the previous year of 18.1% and an increase over the previous four-year average of 21.8%!

Clearly there has been some recent cost cutting at Owens & Minor with regard to the making of

their product lines.

There is one cause for concern in the income statement however. While Owens & Minor

has done an admirable job of decreasing production costs in the past year, the same cannot be

said of their selling, general and administrative (SGA) expenses. This figure has been moving in

the wrong direction more often than not.

In our five-year study, the only period in which Owens & Minor decreased SGA from the

previous year was between 2009 and 2010. In 2010, SGA decreased by 5% from the previous

years’ SGA. Beginning in 2011 however, SGA increased 8.2% from the previous year. In 2012

the increase in SGA was 11.8% and in 2013 it increased 26.5% from the previous year!

One may ask, is the increase in SGA reflective of an increase in the number of

employees, so that the per-capita SGA may actually be steady or even lower with each

11

successive year? A valid question, and here are our findings using the employee numbers

reported each year by Owens & Minor in their 10-K.

In 2008 OMI had 5,300 employees according to the company’s 2008 10-K. In the 2009

10-K, 4,800 employees were reported. Despite the fact that 500 workers had been shed during

the year, SGA increased from $521.4 million in 2008 to $592.3 million in 2009. This is an

increase in SGA of 13.6% purely in dollar-terms; when one factors in the difference of 500 fewer

workers between 2008 and 2009, then the per-capita SGA actually increased by 25.4%.

For the next two years, through 2011, OMI maintained a workforce of 4,800. During this

time SGA decreased almost 5% in 2010 but then increased over 8% in 2011 to a new high. The

workforce changed drastically in 2012, with the year-end number coming in at 6,500. This can

be directly attributed to OMI’s acquisition of Movianto in August of 2012.

SGA did increase in 2012, from $610.7 million the previous year to $682.6 million for an

increase of 11.8%. When the 2012 SGA is divided among 1700 additional employees however,

the per-capita SGA number drops dramatically. Consider though that these 1,700 new

employees were not counted until the acquisition was completed starting in September of 2012.

To remedy this we did a ‘weighted workforce’ calculation as follows: (4,800 + (1,700*(4/12)))

for an adjusted 2012 workforce of 5,367. When this adjusted workforce number is applied to the

2012 SGA, the per capita becomes almost exactly the same as the 2011 per capita.

Finally, in 2013 the OMI employees were reported as 6,700. The 2013 SGA did increase

enough that, even with 200 additional employees to divide by, the per-capita still increased.

Here is a five-year performance picture of OMI’s per-capita SGA.

12

SGA Workforce Per Capita % Change

2009 $592.34M 4,800 $123,404

2010 $564.17M 4,800 $117,535 -4.8%

2011 $610.66M 4,800 $127,220 8.2%

2012 $682.60M 5,367 (adjusted) $127,192 -0.002%

2013 $863.66M 6,700 $128,904 1.3%

We’ve gone into quite a bit of detail on the subject of SGA, but the pattern of increasing

SGA is a definite cause for concern among current and potential stockholders. If management is

going to maintain a tight grip on the cost of goods sold, but then spend even more money on

SGA, then the ultimate goal of making the company more profitable and its stock more valuable

will have trouble coming to fruition.

Rather than studying every line item of the earnings report in the same manner as the

SGA expenses above, we thought that a more concise method would be to study pretax income

as a percentage of revenues. This should give a good idea of how the company is doing at

controlling its in-house, variable expenses. Tax would not meet this criteria since it is controlled

by the IRS rather than by the company and, while the amount of tax paid does vary naturally, the

rate of taxation should be fairly consistent since it is always a percentage of income after

expenses.

This study was revealing as well as concerning. Beginning in 2009 again, pretax income

represented 2.34% of revenues. By 2013 that percentage had dropped to 2.04%. While the

amount of the change may seem like a bit of atom-splitting (0.3%), consider that the rate of the

13

change over the five-year period is just under 15%! Consider also that during the periods from

2009 through 2013, pretax income as a percentage of revenues never once went up from the

previous year. The results for the period were:

Pretax Income as a Percentage of Revenues Percentage of Change

2009 2.34%

2010 2.24% -4.76%

2011 2.20% -1.61%

2012 2.07% -6.42%

2013 2.04% -1.39%

So here is something else to give pause to both the current stockholder as well as the

prospective stockholder.

Recommendation

Based on our analysis of Owens & Minor, our current recommendation on whether or not

to buy the stock is, “No.” This is a “no” that must come with some qualifications and

explanations though. While we recommend that a potential investor not buy shares of Owens &

Minor right at the moment, we do feel that OMI is a stock that is healthy enough to merit

continued monitoring and possible investment in the future.

Aside from the aforementioned weaknesses that we identified in Owens & Minor, one

crucial consideration is that Owens & Minor is currently close to its historic high and has gone

up considerably in the past year.

14

At the beginning of 2009, OMI shares were trading at $22. One year later, at the

beginning of 2010, OMI had risen to $28.50 per share. This was an increase of 29.5% during a

market year that was very tough. One can speculate that because OMI was not involved in

anything related to banking or real estate and that talk of changes in health care was already

under way, investors ran into OMI as well as similar stocks because they would have been seen

as belonging to a ‘safe sector’ in comparison to other market sectors at that time.

For the next few years, from the beginning of 2010 through the beginning of 2013, OMI

stock remained very steady. While it did briefly go as high as $35 per share in 2011, most of the

period from 2010 to 2013 was spent within a band of $28-32 per share.

That changed in 2013 when the stock began the year at $28.25 per share and then

finished the year at $36.00 per share for a gain of just under 27.50%. The stock actually peaked

in November of 2013 at $38 per share before it began to give up some ground with some normal

end-of-the-year selling off, which can usually be attributed to investors who were already

thinking of selling before years-end anyway.

Since the beginning of 2014, OMI has been holding its own at between $34-36 per share.

Keep in mind though that this is only between 5-11% off of its historic high and following a year

in which many retreats were found in its most important figures and ratios, many of which were

previously discussed.

OMI does have many strengths though, also previously discussed. For this reason we

believe that it is not ideal to forget Owens & Minor but rather to monitor it for future

performance and future fluctuations in share price.

15

If there were to be a significant correction in the market and OMIs share price saw a

decline that may even put it back in to the $25-30 per share range, then as long as the company’s

fundamentals have had some improvement in key areas, it might be worth revisiting the

possibility of buying some OMI shares.

An ideal place to start would be a rising current ratio rather than a declining one. A

decline in per-capita SGA would be good to see also. Another definite improvement to look for

in OMI’s subsequent annual reports is for its newly acquired international segment, Movianto, to

beginning producing profits rather than losses.

The bottom line is that while Owens & Minor is not recommended for investment right

now, it could become a value stock at some later date and does deserve future watching.

16

Citations

Owens & Minor Inc. (2014). Company Information. Retrieved April 5, 2014 from

http://www.owens-minor.com/companyinfo/Pages/default.aspx

PRN Newswire (2013, September 28). Owens & Minor Earns Investment Grade Rating from

S&P. Retrieved April 14, 2014 from http://www.prnewswire.com/news-releases/owens--minor-

earns-investment-grade-rating-from-sp-55427167.html

Securities and Exchange Commission, EDGAR Database. (2008-2013). Owens & Minor Inc. 10-

K Annual Reports. Retrieved April 5, 2014 from https://www.sec.gov/cgi-bin/browse-edgar?

action=getcompany&CIK=0000075252&type=10-k&dateb=&owner=exclude&count=40

Yahoo Finance (2014). Owens & Minor Inc. Competitors. Retrieved April 12, 2014 from

http://finance.yahoo.com/q/co?s=omi