This column was originally published on RealMoney on July 24 at 12:57 p.m. EDT. It's being republished as a bonus for readers.

Needle safety has always been important, but it only became a business after HIV emerged n the 1980s. Many new safety products were introduced, and ICU Medical ( ICUI) established itself as a pioneer in the field.

Since launching its first product in 1984 -- a locking system for intravenous lines that prevented accidental disconnection from patients -- ICU Medical has grown substantially, generating high returns on invested capital and lots of cash for shareholders.

In 2005, management demonstrated it could reliably turn the fortunes of the company around after a dismal 2004, but the company is ready to bear more fruit from several initiatives that should drive earnings growth for years to come.

High-Efficiency Manufacturer

ICU Medical's product lineup is largely made up of small disposable plastic devices that are used for infusion sets to test blood or deliver drugs. The company's relatively small but expanding product lineup is led by its Clave needle-free connectors, which generated more than $60 million in sales last year and $34 million in the first half of 2006. The larger drug-delivery system maker Hospira ( HSP) distributes most of ICU's products.

ICU has patents on its devices, but competing products are available. One of the key elements in ICU's success has been its manufacturing efficiency. The company consistently operates on a lean inventory base, turning over inventory six times a year. At the same time, the company delivers gross margins around 45%, even though it its products are largely priced at $1 to $2 per device.

ICU has built a successful business in custom infusion-set product design that takes advantage of its manufacturing efficiency. Many physicians and hospitals want different infusion-set configurations due to their unique needs. ICU can assemble customized infusion sets in a consistent and profitable fashion. Many other companies, including Hospira, have exited this business because they could not operate it profitably. Hospira eventually outsourced all its custom business to ICU, and their relationship has blossomed as a result.

Fat Product Pipeline

Two factors are helping ICU gain market share in what is a slowly growing market. One of Hospira's competitors, Baxter ( BAX), was forced to recall one of its infusion pumps. As a result, Hospira was able to gain share in the pump market, which has had a knock-on effect for sales of ICU infusion products.

In addition, an independent study conducted by clinicians at Johns Hopkins Hospitals demonstrated that catheterized patients who are hooked up with ICU's Clave needle-free connectors have lower rates of bloodstream infections than patients on whom Alaris Medical Systems' -- a unit of Cardinal Health ( CAH) -- Clave-like device is used. ICU's marketing team is aggressively promoting the results of this study.

New products are the real engines of long-term growth for ICU, though. It's in the early stages of rolling out three innovative products that address markets totaling several hundred million dollars:

  • The Orbit is a diabetes infusion set with a connector that swivels 360 degrees, which makes it more comfortable for patients to use. I believe that this is a $120 million market opportunity alone.

  • The Tego, a specialist connector for dialysis patients, addresses a $40 million annual market, and so far the reception from clinicians has been very positive.

  • The Genie is a vial-access protection device initially targeted at oncology clinics. The device protects clinicians and patients from spilling or splattering toxic drugs when they are drawn from their vials. The oncology market could be a $50 million to $100 million opportunity.

ICU's critical-care division is also planning to introduce a variety of new products in 2007, the nature of which ICU and Hospira have been very tight-lipped about. It will take time for the company to win market acceptance for all these new products, but the company could double its revenue base over the next few years.

From an operating perspective, ICU should be able to generate a lot of leverage in 2007. Due to consolidation of manufacturing facilities and moving some production lines to Mexico, the company expects to be able to increase gross profit margins by 500 basis points by the end of 2007. In addition, much of the new sales and marketing infrastructure added through 2006 will be in place, and the rate of spending growth in 2007 should decline.

In its earnings report last week, the company lifted its forecast for 2006 to revenue of $195 million and $1.65 in earnings per share, up 26% and 22%, respectively. Though about half of the company's revenue growth in 2006 will be due to ICU's acquisition of Hospira's critical-care infusion-products division, ICU's organic growth should continue to be impressive, driven by market-share gains of legacy products, new product launches and improving operating efficiencies.

I expect 2007 revenue growth to exceed 10%, but I expect earnings per share to grow nearly 25% from 2006 due to enhanced manufacturing efficiencies and operating leverage. The consensus earnings estimate for 2007 is $1.90, an increase of 15%.

ICU's recession-resistant qualities are particularly attractive to me right now. If ICU Medical can continue to execute and grow its fat cash balance, which now stands at roughly $6.50 a share, I expect the stock could trade in the low to mid-$50s in a year's time.
At the time of publication, Ferayorni was long ICU, although positions may change at any time.

Justin Ferayorni, CFA, is the founder and principal of Tamarack Capital Management and was an analyst and portfolio manager at Bricoleur Capital. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ferayorni appreciates your feedback; click here to send him an email.

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