Value Line assigns Financial Strength ratings across a spectrum from A++ (Highest) to C (Lowest). Generally speaking, the largest companies with the strongest balance sheets get the highest scores. Factors considered in making a ratings determination include balance sheet strength, corporate performance, company size (with earnings more important than sales), stability of returns, and business outlook, among others.
The covering analyst reviews a company’s Financial Strength rating quarterly. If he or she believes a change is needed, the recommended change is brought to the attention of a senior analyst. The covering analyst must then defend the decision based on his or her knowledge of the company and its industry. If the analysts are in agreement, then a change is made. If there is still a question, the analyst may be asked to monitor the company’s finances carefully over the next three to six months.
Market events may also affect Financial Strength ratings, so that the above process may take place at any time. A senior analyst who has noticed a particular trend in an industry or sector may also initiate a re-evaluation of a Financial Strength rating. In this case, the senior analyst may ask an individual analyst or a collection of analysts to review the financials and report back.
The Financial Strength rating and a stock’s Price Stability rank are the two main components used to determine Value Line’s proprietary Safety Rank, which measures the total risk of a stock relative to the approximately 1,700 other stocks under Value Line review.
Although a company’s Financial Strength rating is just one factor among many that investors should consider, it is an important one. Moreover, shareholders should take particular note of changes in this rating—both up and down. Value Line subscribers have access to our complete list of Financial Strength upgrades and downgrades each week in the Selection & Opinion section of the product. Noted here, is a recent upgrade awarded CryoLife Inc. (CRY), Cutera, Inc. (CUTR) and LCA-Vision Inc. (LCAV) both received a downgrade, meanwhile.
CryoLife is a distributor of cryogenically preserved human tissues for cardiac and vascular transplants. It also manufactures implantable medical devices. The company’s main products include BioGlue, BioFoam, HemoStase, and PerClot. Last year, international sales comprised about 17% of total sales, but CryoLife has entered new partnerships with a German-based distributor, which may well help bolster its global position in the coming quarters.
Last year, the company eliminated its long-term debt. What’s more, it ended the quarter with a decent amount of cash in its coffers, leading us to raise its Financial Strength rating one notch from C++ to B. Even though Cryolife may rely on its revolving credit facility to fund acquisitions —such as its recent purchase of the remaining interest of joint venture ValveXchange— we imagine that management will focus on maintaining a healthy balance sheet, with little to no debt obligations.
Despite our upgrade to the company’s Financial Strength rating, Cryolife still holds a weak score for Price Stability. The stock has been on a bumpy ride over the past couple of years, which was somewhat exacerbated by a difficult macroeconomic backdrop. What’s more, the company faced a great deal of stress last year, due to the failed takeover attempt of Medafor, one of its key HemoStase suppliers. Even though CryoLife has recovered from that misadventure, investor concerns regarding the company’s return on its portfolio of products may add some volatility to these shares’ behavior in the near term. Accordingly, we have kept our Safety rank at 4 (Below Average).
Others in the medical device industry may not fare as well. Specifically, we have downgraded our Financial Strength ratings for both Cutera and LCA-Vision. Both of these companies focus on elective medical procedures, which many consumers have put on the back burner due the recent turbulence in the macroeconomic environment.
Cutera, Inc. designs, develops, manufactures, markets and services laser and other light-based aesthetics systems for practitioners worldwide. The procedures these devices execute include hair removal, leg and facial vein removal, skin rejuvenation, tissue tightening, and wrinkle treatment. In 2010, international revenues accounted for 64% of the top line.
The company’s bottom line has been lingering in the red for the past three years. And even though Cutera posted better-than-expected results for the June quarter, it will likely continue to struggle in the near term. Indeed, the company will probably post a share loss, albeit somewhat smaller, this year, and may not return to profitability until 2013 at the earliest.
Many of its customers have scaled back discretionary spending, especially those related to cosmetic and elective medical procedures. Although the company has ramped up its research & development outlays to expand its roster, and has turned to other aesthetic markets (i.e., podiatry) to boost its market share, lackluster demand for its core line of products will likely continue to weigh on near-term results. The company’s prospects to 2014-2016 look brighter, as demand should eventually return, giving the shares above-average recovery potential. As a result of all this, we have lowered the Financial Strength from a B to a C++.
LCA-Vision has also struggled due to difficult operating conditions. The company develops and operates fixed-site laser vision correction centers, under the LasikPlus brand name. Lasik (laser-assisted in situ keratomileusis) is a laser-based procedure designed to reshape patients’ eyes and restore vision. At the end of the year, it owned and operated 54 vision correction centers. The majority of its business is based in the United States, but it has some holdings in Canada.
The company has shuttered several of its underperforming vision centers. Although this move will likely boost margins over the long haul, the reason behind this decision, namely the weak demand for the eye-care procedure, may well continue to plague LCA in the coming quarters. The company has also cut much of its discount pricing and promotional activity. This, coupled with high unemployment rates and wavering consumer confidence, will likely continue to restrain results. All told, the Lasik provider’s revenues will likely limp along, and the company may well register share losses this year and next.
It has begun to expand its product portfolio over the past few months, adding sunglasses and reading glasses to its vision centers. Going forward, the company may begin testing whether it will include cataract or intraocular surgeries to its roster. Nevertheless, the diversification efforts may not be accretive for the next couple of years.
Overall, investor confidence in the company’s prospects may continue to weigh on its price performance. The company holds a very low score for Price Stability, owing to the uncertainty surrounding its core business. Consequently, we’ve chosen to reduce the company’s Financial Strength rating at this time.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.