Small-Cap Spotlight: Omnicell Under the Microscope

With economic weakness continuing to hit both large-caps and small-caps, today's Small-Cap Spotlight looks at Omnicell(OMCL Quote), another stock that could provide investors with nice returns even in a tough market.

The company offers an under-the-radar play on the health care industry, targeting improved efficiency and patient safety in prescribing medications. The company's products range from software for ordering prescriptions to mobile organizers and storage systems used in hospitals.

Prognosis Mixed for Omnicell

Kusick: Omnicell Offers Growth and Safety

In last week's Spotlight, we offered Dawson Geophysical(DWSN Quote) as a name that small-cap investors could rely on even in a weak market. In the days since our last feature, it seems the economic outlook has only gotten worse, with a U.S. recession in 2008 looking more likely with each new set of economic data.

In the current market, investors should do their best to control the urge to move entirely to cash. While it's important to have some funds ready to put to use gradually as some best-in-breed names decline alongside the indices, investors looking for long-term returns need to "pick the right tool for the job," so to speak.

In this case, our job is to find small-cap picks that are less susceptible to the economic pressures that continue to weigh on the broader markets. Health care has always been a sector with many subdivisions worth considering, from pharmaceutical makers to health care plans to hospitals.

With the stock market heading into bear market territory, virtually all of health care looks a lot more appealing thanks to the sector's limited leverage to broad economic weakness. Coach(COH Quote) stores may be empty and Google(GOOG Quote) may see a slowdown in ad revenue, but you won't see a reduction in hospital traffic.

The key driver for Omnicell is the constant search for additional efficiency and patient safety in all health care settings. The company has delivered in this respect, and as a result of the steady demand for its products, Omnicell has posted nine consecutive quarters of revenue growth.

During that time (from June 2005 to the present), sales have grown 93%, from $28.6 million to $55.2 million. Operating margins -- a key indicator of whether the business is taking off -- rose steadily over the same period, going from slightly negative in mid-2005 to above 14% for the most recent quarter. Gross margins have held steady in the low- to mid-50% area.

Current analyst estimates have Omnicell's 2008 earnings per share declining to 88 cents from $1.01 in 2007, but a closer look shows that the decline is a result of the company finally hitting a normal tax rate of around 38% from recent years when it benefitted from a lower effective tax rate (in the single digits) relating to operating losses in earlier years.

For a better idea of Omnicell's growth rate, we should use EBITDA (earnings before interest, taxes, depreciation and amortization). Consensus estimates currently have the company's EBITDA increasing to $40.31 million this year from $31.85 million in 2007, for a growth rate of about 27%. Because a potential U.S. recession is unlikely to significantly affect Omnicell's growth potential, I think investors are getting a bargain here. The stock has a P/E ratio of 26 times 2007 earnings (or just under 30 times 2008 consensus estimates).

Ideally, I'd like to see management show increased commitment to controlling expenses. Not that expenses have been extremely high in recent quarters, but as sales continue to grow at a steady pace, a good growth company that's properly scaling its business should show declines in SG&A expenses (that's sales, general and administrative) as a percentage of revenue.

Omnicell's SG&A expense ate up 42% of revenue last year, but has come in under 40% in the first three quarters of 2007. If management is able to keep this number trending lower over time, it will be a great sign for investors that the company can continue to benefit from traditional economies of scale.