Varian Medical: A Healthy Buy

Eddy Elfenbein submits: Varian Medical Systems (VAR) took a big hit on Friday, dropping 7.3% on news of lower revenue guidance. But the stock's defenders are coming out in full force. Joshua Lipton of Forbes noted the positive views of many analysts:

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In a client note, Citigroup analyst Amit Bhalla wrote that while North America has not displayed signs of weakness in past quarters, the results do appear explainable.

The North America miss, Bhalla wrote, was due to timing of customer buying patterns and had the quarter been one week longer, orders would have been $20 million higher and total North America oncology net orders would have been flat, instead of down 10%.

Bhalla said, "As was the case in Europe last quarter, the company does not believe that it has lost orders to competitors in North America and we believe this to be the case as well."

Bhalla maintained a "buy" rating on the shares. He lowered his price target by $2 to $60.

Standard & Poor's Equity Research analyst Robert Gold also continued to believe that Varian is a wise buy.

In a client note, Gold wrote that he was disappointed by the 10% decline in U.S. oncology orders.

"However, we believe an increased size of average orders, and a slightly more competitive market are extending the selling cycle a bit and have pushed some booking into the third-quarter," Gold wrote.

He said that he still sees full fiscal 2007 revenues of about $1.8 billion and earnings per share of $1.83. He maintained a "strong buy" opinion on the shares.

Comments

[AlanBrochstein]

Eddy, I have followed VAR for a while and think very highly of the company's products and market leadership. While at my former firm, I initiated a long position in early 2005, my most recent involvement has been from the short side despite my favorable long-term view of the company (no position now). My concerns have been two-fold. First, and most importantly, the IGRT ramp was significantly steeper than that of the IMRT ramp several years ago, which, in my opinion, has resulted in analyst extrapolation at too high of a growth rate. In other words, because it grew so fast, analysts assumed that the ultimate growth would be higher than I believe it will be. I am happy to discuss this further with anyone who wants to email me (alan@analystforhire.c... The second reason is that the company has been spending more than all of its free cash flow on share repurchases, which has served to make EPS growth look more impressive than the underlying growth of the company.

Bottom-line: Great company, but still too expensive at 23X forward estimates (though getting closer to fair, as I have been making these points since it traded at almost 30X late last year. From a technical perspective, the stock needs to break 48 in order to move to neutral from negative. Not a short, though, given its strong competitive position and financials.

[eddy]

Thanks Alan. Those are great points. I think if VAR pulls back to $40 it's a great buy. It's a remarkably strong business. We'll learn more next week.

[AlanBrochstein]

I wouldn't hold your breath for $40 - today's blip might get it a tad under 42... Probably a good long-term entry point at 41.75. I might go long there if it prints, at least for a trade.