Though not immune to market fluctuations, medical equipment companies like Hanger Orthopedic Group Inc. (HGR) make good stocks for a long-term hold. Since bottoming out in late April, Hanger Orthopedic stock has appreciated over 70% and currently trades around $17.
As the demand for orthotic and prosthetic services continues to grow due to ageing population and skyrocketing diabetes rates, Hanger Orthopedic stands to benefit greatly.
Overview
Based in Bethesda, Maryland, Hanger Orthopedic Group, Inc., a provider of orthotic and prosthetic (O&P) patient care services, was founded in 1861 by James Edward Hanger who became the first amputee of the Civil War. Hanger fashioned an artificial leg for himself and patented his prosthetic device. Since then, the company has developed many revolutionary products, helping veterans and other amputees regain mobility. The company has four subsidiaries - Hanger Prosthetics and Orthotics, Southern Prosthetic Supply Inc., or SPS, Innovative Neurotronics Inc., and Linkia. Hanger Orthopedic conducts business in two segments - patient care services and distribution.
Leading market position
Hanger Orthopedic accounts for about 25% of the estimated $2.5 billion O&P (orthotic and prosthetic) patient-care market, in the United States. The company is devoid of strong competition as none of its patient care competitors account for a market share of more than 2% of the country's total estimated O&P patient care services revenue.
Prosthetics and Orthotics is the core business of Hanger Orthopedic. While prosthetics is concerned with the design, fabrication and fitting of artificial limbs for those who have lost a limb because of a congenital defect, disease, or trauma, orthotics involves the design and use of braces to support or supplement weakened joints or limbs.
Hanger Orthopedic distributes more than 270,000 O&P product offerings, through its subsidiary Southern Prosthetic Supply Inc, or SPS, the largest O&P distributor in the world.
Through its subsidiary Innovative Neurotronics, Inc.,or IN Inc., the company develops new products for patients who have had a loss of mobility due to strokes, multiple sclerosis or other similar conditions.
Hanger Orthopedics' subsidiary, Linkia is a managed care organization, which coordinates and manages all O&P services and needs of its contracted healthcare partners through a customized network of O&P patient care facilities. According to the company, Linkia expanded its network of independent providers to 280 in 2007, up from 150 in 2006.
Favorable demographics
Vascular disease and diabetes are the leading causes of amputation in the U.S. The risk of amputation increases with age as there is a direct correlation between age and the onset of vascular disease and diabetes. Peripheral vascular disease, which occurs mostly in older people, restricts blood supply to the limbs due to the narrowing of blood vessels.
Poor blood circulation makes the limbs vulnerable to injury, infection and delayed wound healing. The growth rate of the over-65 age group is nearly triple that of the under-65 age group. According to the World Factbook, the percentage of population aged 65 and above in the U.S. has increased to 12.7% (data as of May 21, 2008) from 12.5% in 2006. The number of elderly people who require orthopedic rehabilitation services and products has increased due to broader medical insurance coverage, increasing disposable income, longer life expectancy, greater mobility expectations and improved technology of O&P devices.
The company's net sales attributable to its patient-care services segment were $571.7 million in 2007, compared to $543.2 million in 2006, reflecting the increased demand for orthotic and prosthetic services. Net sales attributable to distribution segment were $64.4 million in 2007, up from $55.4 million a year before.
Rising diabetes and obesity rate
Though the risk of amputation increases with age for all individuals, it is much greater for diabetic patients. According to the Centers for Disease Control and Prevention, or CDC, 24 million people in the United States are affected by diabetes, an increase of more than 3 million in approximately two years. Yet another 57 million people are estimated to have pre-diabetes, a condition that puts people at increased risk for diabetes, as per the latest statistics. Diabetes is one of the leading causes of amputation of the legs or feet in the U.S. where an average 140,000 amputations are performed every year.
An increase in obesity rate directly co-relates with an increase in diabetes. According to the annual report released by the Trust for America's Health, over 25% of adults are obese in 28 states, compared to 19 states a year before. The demand for prosthetic and orthotic services increases as the diabetic population with orthopedic impairments grows. An increase in amputee population boosts opportunities for Hanger Orthopedic.
War on terror
The war on terror in Iraq, Afghanistan, Pakistan and other regions increases the number of veterans' suffering from traumatic amputations, leading to a spike in demand for prosthetic products and services.
Earnings scorecard
In three out of the last five years, the company reported a profit. Hanger Orthopedic recorded losses for the years ended December 31, 2006 and 2004.
In 2007, Hanger Orthopedic's net income applicable to common stock was $17.6 million or $0.64 per share, compared to a net loss of $4.08 million or $0.19 per share in 2006. Net sales for 2007 were $637 million, up from $598.7 million a year earlier. Same-center* net sales grew 5% in 2007, compared to 2.2% growth in 2006. (*Patient-care centers that have been owned by the company for at least one full year). The number of patient-care centers at the end of fiscal 2007 increased to 636 from 618 a year before.
In 2006, the company incurred a charge of $17.0 million related to debt and preferred stock refinancing. In 2004, Hanger Orthopedic experienced the first of three years of reimbursement freezes mandated by the "Medicare Prescription Drug Improvement Act of 2003" and also incurred $45.8 million in goodwill impairment charge, which resulted in the company reporting a loss that year.
For the second quarter ended June 30, 2008, Hanger Orthopedic's pro forma net income climbed to $8 million or $0.25 per share from $5.0 million or $0.17 per share in the second quarter of last year. The pro forma results for the second quarter of 2008 assume that a one-time, in-kind preferred stock dividend occurred and the preferred stock was converted to common stock at the beginning of the period.
On a GAAP basis, net income applicable to common stock, which includes the full impact of the $5.3 million one-time non-cash dividend dropped to $2.8 million or $0.11 per share for the quarter ended June 30, 2008.
Net sales for the quarter grew 13% to $181.2 million from $160.4 million a year ago, and topped analysts' estimate of $171.1 million. Same-center net sales for the quarter rose 8.9%, compared to 4.2% growth in the year-ago quarter.
Positive earnings surprises
The company has topped earnings expectations during three out of the past four quarters by an average surprise of 20%.
Outlook
Buoyed by its solid performance in the first-half, Hanger Orthopedic lifted its pro forma earnings forecast for the full year of 2008 to $0.80 - $0.82 per share range from its prior outlook of $0.75 - $0.77 per share. The company also boosted its sales guidance for the year by $10 million to range between $680 million and $690 million. FirstCall/Thomson Financial analysts have earnings estimates pegged at $0.82 per share and revenue estimates of $695.05 million. Analysts are projecting an average annual growth rate of 13% over the next five years.
Innovative products
The company continues to churn out innovative products, which are available through its practitioners. ComfortFlex Socket System, Insignia, and WalkAide are the company's patented products that provide comfort and mobility to patients. In July 2007, the company's subsidiary Innovative Neurotronics Inc. inked an agreement granting Teijin Pharma Ltd. exclusive rights to develop and commercialize WalkAide in Japan.
Hanger Orthopedic also offers i-LIMB Hand, developed by Touch Bionics, in its prosthetic clinics. The i-LIMB Hand is the only upper-limb prosthetic device that imitates the true movement and accuracy of the human hand.
Acquisitions
Hanger Orthopedic continues to make smart tuck-in acquisitions, thereby boosting its profits and sales.
On January 31, 2007, the company acquired Custom Footwear Inc, a manufacturer of men's orthopedic shoes. In June of last year, Hanger Orthopedic snapped up Paris Orthotic & Prosthetic Laboratory, a provider of orthotic and prosthetic services. The following month, the company acquired certain assets of Surefit LLC, a manufacturer and wholesaler of orthopedic equipment. Hanger Orthopedic continued its string of acquisitions for the remainder of last year and added Opelika Prosthetics & Orthotics Inc, a manufacturer of artificial limbs, Stagner Orthopedic Services, an owner and operator of orthopedic rehabilitation center and MHC Prosthetics, LLC, to its portfolio.
In February 2008, the company acquired Precision Orthotics of Tuscon Inc, an orthotics medical equipment provider. Colorado professional Medical Inc, Beverly Hills Prosthetics Orthotics Inc, Orthotic Prosthetic Center Inc and Compton Jones Orthotics LLC were the other companies that were acquired concurrently by Hanger Orthopedic.
Tri-State Prosthetic Orthotic Center Inc, a manufacturer of medical devices and equipment was acquired by Hanger Orthopedic in early May. As recently as September 11, the company purchased three new care centers - Advanced Prosthetics of America, Inc., Manhasset Orthotics-Prosthetics, Ltd., and Custom Design Orthotic & Prosthetic.
Recurring stable revenue
There is stable, recurring revenue in the O&P (orthotic and prosthetic) industry due to the need for periodic replacement and modification of O&P devices. According to Hanger Orthopedic, the average replacement time for orthotic devices is one to three years, while the average replacement time for prosthetic devices is three to five years.
Debt & Liquidity
The company's total debt as of June 30, 2008 was $406.3 million, a decline from $410.20 million at March 31, 2008 and $410.89 million at the end of the fourth quarter of fiscal 2007. Declining debt level means declining interest expense, which could result in improved profits.
Hanger Orthopedic's return on equity, or ROE, for the past twelve-month period is 10.06%, compared to an industry average of 15%. For every dollar invested, the company returns 10 cents to its shareholders.
Total current assets are over 4 times current liabilities, implying that the company is in good short-term financial standing.
Risks
Changes in reimbursement rules
The prosthetic fitting process is quite expensive and is covered by Medicare, Medicaid and other insurance of national and local nonprofit organizations, which set a maximum reimbursement levels for O&P (orthotic and prosthetic) services and products. About 94% of Americans aged 65 and older are covered by Medicare, while 60% have some type of private health insurance, according to Veterans Health Administration.
Hanger Orthopedic derives a significant portion of its net sales from reimbursements for O&P services and products from programs administered by Medicare, Medicaid and the U.S. Veterans Affairs. For the recent second quarter ended June 30, 2008, the company derived 39.8% of its net sales from reimbursements for O&P services and products. If the Medicare or Medicaid agency reduces reimbursement levels for O&P services and products in the future, the company's net sales could substantially decline.
Conclusion
The growing baby boomer population seeking orthopedic rehabilitation services, the rising rate of obesity and increasing incidence of diabetes boost opportunities for Hanger Orthopedic, positively impacting its stock price. Like any medical device maker, Hanger Orthopedic's sales could suffer due to unfavorable changes in Medicare and Medicaid reimbursement rules, causing a downward pressure on its stock.
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