February 04, 2011 - 1:44pm EST by
2011 2012
Price: 265.00 EPS $1.39 $1.63
Shares Out. (in M): 91 P/E 29.0x 25.0x
Market Cap (in $M): 3,842 P/FCF 0.0x 26.0x
Net Debt (in $M): -129 EBIT 184 225
TEV ($): 3,713 TEV/EBIT 20.0x 16.5x

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Elekta (EKTAB SS) is a typical growth at value position or "compounder". The market is sceptical of Elekta's ability to continue to generate >10% organic growth for the medium term and to deliver operating leverage leading to an EPS CAGR of >15% over the next 5 years.

Elekta is a €2.9bn, Stockholm-listed medical device manufacturer. The company is the global #2 linear accelerator (linac) manufacturer (behind US-based Varian). Linacs are used to treat all forms of cancer by directing a highly accurate beam of ions at cancerous cells in order to kill them. Over the past 7 years Elekta has generated 13% organic growth owing to strong structural growth behind the treatment of cancer. Firstly, the diagnosis of cancer is growing in-line with global GDP, but over time, the proportion of cancer treatments through radiotherapy, rather than surgery or chemotherapy is increasing dramatically. Historically, radiotherapy was used only as pain treatment rather than for curative purposes but recent research has shown how effective linacs can be for both. Also, radiotherapy is far lower cost to a hospital as the patient can be treated as an outpatient rather requiring a hospital stay.

Emerging markets account for >25% of Elekta's sales and have grown at >30% per annum for the last 5 years, but still have a long way to catch up the developed world. The BRICs have only one linac per 2.6m people, versus the US with one per 84,000.

At the same time, Elekta has show significant margin improvement through operating leverage with EBIT margin growing from 10.5% to 16.1% over the last 4 years. The consistent 30% contribution margin will continue and allow margins to improve up to at least the level of the company's more mature competitor Varian, with a 22% EBIT margin.

Barriers to entry are extremely high, with significant regulation and high switching costs for hospitals in the installed base, which allows Elekta to generate returns on invested capital in FY10 (YE April 2010) of >25%. Those returns should improve as sales grow and profitability improves on a stable asset base.

In the absence of a re-rating for Elekta, but given EPS growth of >15% per annum we would expect the stock to appreciate at least in-line.  At the same time, in the absence of M&A, the company has signalled its intention to return cash generation to shareholders which would give a c.5% net dividend yield.

VALUATION: We use a DCF to derive a fair value for Elekta which points to an intrinsic value of SEK340 per share or 30% upside. The company is running with net cash and has a low beta of 0.75x leading to a WACC of 8%. EBIT will grow at 15% CAGR for the next 5 years owing to organic growth and operating leverage followed by medium term growth of 9% as EBIT grows in-line with sales. We reduce the terminal growth to 3%. Ex-GW the ROIC has been >50% over the last 4 years and owing to the operational leverage including GW the ROIC should improve from 25% in year ending April 2010 to c.50% by 2014. Owing to the extremely high barriers to entry the company should be able to sustain ROIC at the higher end of 2-3% over WACC for our terminal value.

At our price target the company would trade on 24x year ending April 2013 which is no re-rating relative to the current price of 24x year ending April 2011.

The company is currently running with net cash versus a historical 1x ND/EBITDA with the intention to maintain some firepower for M&A. However, according the CFO it would be entirely reasonable to return cash generation to shareholders which would extend the current 1-2% dividend yield to 5%.


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