Cooper Companies

CooperCompanies delivered 1% and 4% revenue and adjusted earnings per share growth, respectively. Full-year guidance for both figures was lowered by a low-single-digit percentage. Shares traded down 17% after hours.

Why it matters: This quarter’s results paint a starkly different picture from Cooper's strong first-half performance. CooperVision reported flat sales, marking its weakest year-over-year comparison in the past four years, while updated guidance suggests another quarter of revenue declines to close out the fiscal year. Inventory destocking following elevated channel inventories at US customers created roughly a 700-basis-point headwind and was the only drag on regional growth. While we view destocking as temporary, management also cited weak execution stemming from an underbuilt salesforce and marketing organization. We view this as a bigger challenge, as rebuilding these capabilities could take considerably longer. APAC weakness looks persistent, with organic sales down 5%, marking the fifth consecutive quarter of top-line headwinds. We think it's hard to find any near-term catalysts that turn the ship around.

The bottom line: We lower our fair value estimate to $71 from $87 after trimming near-term assumptions to reflect the updated outlook and applying an updated weighted average cost of capital, which we raised to 8.4% from 7.5% to reflect a higher equity risk premium and beta. We also raise Cooper’s Uncertainty Rating to High from Medium to reflect elevated stock volatility in recent quarters, two consecutive quarters of lowered guidance, and increased risk that near-term growth fails to return to historical levels. Alongside earnings, Cooper announced the results of its strategic review, including the decision to retain CooperSurgical and an expanded share repurchase program. We believe the decision to retain CooperSurgical disappointed investors who, similar to us, view the business as noncomplementary to CooperVision.

We lower our fair value estimate to $71 from $87 after trimming our near-term assumptions to bake in the updated outlook as well as applying an updated WACC, which we raised to 8.4% from 7.5% to reflect a higher equity risk premium and beta.

We forecast mid-single-digit long-term growth for CooperVision, driven by an aging population, an increasing prevalence of myopia, and a favorable product mix. Since roughly three-fourths of contact lens wearers are age 25 and older, an aging population should help expand Cooper’s end markets. Studies have suggested that roughly 30%-40% the population is myopic today, but this number is expected to rise to 50% by 2050, and we expect the contact lens market to grow accordingly.

We also believe a trend toward a more favorable product mix will fuel Cooper’s margin expansion. The industry has seen an increasing portion of lens wearers upgrade their lenses based on modality, lens material, and lens type, a trend that we believe is likely to continue over the next five years. Fifteen years ago, daily lens sales made up less than 20% of the overall lens market, but they now make up more than half. We also see wearers upgrading their lenses to silicone hydrogel lenses due to their improved comfort level. For Cooper, SiHy lenses are typically priced higher and post higher margins than its non-SiHy counterparts, and we expect Cooper’s top- and bottom lines to enjoy a nice tailwind as this trend continues. Ten years ago, about a third of total segment sales came from SiHy lenses, but with an increasing number of available SiHy lenses from Cooper and a greater number of wearers choosing to trade up their lenses, that number has more than doubled. SiHy lenses now make up more than three-fourths of segment sales.

Furthermore, we believe a growing adoption of toric and multifocal lenses, as well as specialty lenses, could benefit Cooper over the long term. Toric and multifocal lenses, on average, have a 25%-50% pricing premium over spherical lenses, and we are seeing a growing base of lens wearers either opting for or upgrading their spherical lenses to toric or multifocal lenses.

We forecast high-single-digit growth for CooperSurgical through our forecast period. Macro drivers behind the growing top line include women delaying childbirth, an increasing awareness of and education on birth control, and improving access to women’s healthcare. We also expect some margin tailwinds over our forecast period as services that Cooper added to the segment through its Generate acquisition post higher margins compared with Cooper’s traditional products. After this acquisition, Cooper now has the broadest medical device coverage of the IVF cycle in the industry.

We assign CooperCompanies a narrow moat rating because we believe its strong brand recognition and technically advanced products (intangibles) and patients’ unwillingness to move to a different product (switching costs) should support economic profits for at least the next 10 years.

CooperVision is a pure-play contact lenses business unit. The US contact lens market is more or less controlled by four players. Johnson & Johnson (about one-third of the market), Alcon and Cooper (25% each), and Bausch & Lomb (10%). We believe Cooper’s contact lens business benefits from intangible assets due to superior products, the company’s continued investment in the area, and brand power. Cooper spends roughly 4% of total sales in research and development, which enables investments in new technologies such as MiSight 1 Day, the first FDA-approved daily soft contact lens for myopia management for children.

Furthermore, Cooper has one of the world’s most comprehensive specialty contact lens portfolios as well as a number of patents that help maintain product differentiation across competitors. For example, Cooper’s patented Aquaform technology, a technique used in its Biofinity (monthly) and Avaira (biweekly) families, makes softer and more flexible lenses by implementing high oxygen transmissibility and a low modulus into its lenses. We believe this innovation is one of many reasons that 24 million wearers choose one of Cooper’s lenses with Aquaform.

With technologically advanced products and appropriate investment, Cooper has been able to expand its presence in a market that is relatively stagnant in terms of share movement. Since 2014, the company has gained a mid-single-digit percentage of market share. We believe Cooper bolsters brand power through an evolutionary compounding of clinical and technical improvements in its products. The company fosters practitioner preference with scientific evidence proven by clinical studies, often spanning years. All of this effort by Cooper reinforces positive perception in its practitioner base, which requires a lot of effort from a competitor to dismantle and convince otherwise.

We also assign switching costs to Cooper’s contact lens business. In the US, a patient must get a prescription from an eyecare professional to purchase contact lenses, and each prescription is brand-specific. Most eyecare professionals stick with just one or two brands because they have strong relationships with manufacturers due to brand loyalty and rebates. They are also unlikely to mix brands because they want to stick with and prescribe products that they are familiar with. New patients looking to get contact lenses have to first get an eye exam, at which point a doctor will recommend a few products depending on vision correction needs, modality (lens wear schedule), and price point. Each contact lens fits differently, and material behavior is different with all soft lenses, so once someone finds contact lenses that they enjoy wearing without any issues, it is highly likely that they will stick with the same ones year over year. On average, a patient sticks with the same contact lenses for seven years. Once customers are comfortable with a product, they are unlikely to switch lenses unless they are trading up for superior products (for example, switching from monofocal to multifocal or toric).

CooperSurgical has two business units: fertility (40% of segment sales) and office/surgical (60%). While Cooper’s equipment and services in both business units contend for a moat with its broad coverage of the IVF cycle, we do not see enough evidence to confidently say that it will earn excess returns for the next 10 years. One of the segment’s most notable products is Paragard, which is made of copper and is the only nonhormonal IUD in the US. Cooper acquired Paragard from Teva Pharmaceuticals in 2017 for $1.1 billion, and the IUD now makes up roughly 20% of total segment sales. Paragard has the longest effective duration (10 years) out of the five FDA-approved IUDs in the US. Paragard has enjoyed 30-plus years of domestic dominance in the nonhormonal IUD market due to the difficult approval process from the FDA (IUDs are regulated as drugs, instead of devices, which make it more costly, challenging, and time-consuming to get approved) as well as its patents. However, a new nonhormonal IUD, VeraCept from Sebela Pharmaceuticals, is undergoing phase 3 trials and is estimated to launch in the next three years. We do not see any meaningful characteristics that separate Paragard from VeraCept. Outside the US, there are over 20 copper IUD options, so Paragard’s dominance is not felt. Besides Paragard, CooperSurgical has facilities for monitoring activity in IVF, stem cell storage services, and egg and sperm donors, and it also has a number of devices for women’s health. In our view, no one device or specific service that CooperSurgical offers materially differentiates itself from others.

Cooper is one of the leading visioncare companies in the world with a proven record of successful product development. Recent innovations like MiSight widen Cooper's end market and fuel the firm's future growth trajectory.

With an increasing prevalence of myopia, especially in children, MiSight and the joint venture with EssilorLuxottica could make Cooper one of the leading players in myopia management.

Favorable global trends such as an aging population, women having children at a later age, and increasing awareness of women’s health should expand CooperSurgical’s end markets.

While the contact lens market share has been stable, lagging research and innovation could start to chip away at Cooper's presence in the space.

Macroeconomic challenges including supply chain issues and inflationary pressures could hinder contact lens wearers from upgrading their lenses and put pressure on Cooper’s sales growth and margin expansion.

Paragard has been the only nonhormonal IUD in the US market, but a recent launch of a competitor could steal share.