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Value Stocks in the Eye of the Storm?

The eye-care industry may offer a respite for investors in turbulent times.

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Eye care is not a cure-all for investors. In fact, several firms with exposure to the LASIK markets have been among the hardest-hit this year. However, eye care is one of the most diverse industries we cover, with certain markets not only resistant to current economic woes but also blessed with terrific prospects for growth. In this article, we'll assess the recession profiles of every pure eye-care firm we cover, separating the economically resilient companies from the dependent ones. In the end, although the spectrum of eye care spans wide, we think one firm will clearly set itself apart from the rest.

Eye Care for All
In one way or another, eye care will affect nearly everyone on the planet. It is estimated that 170 million people in the U.S. alone require some form of vision correction, meaning that more than half of all Americans have eyes that don't work properly. And it gets worse. Unlike your heart, you can't exercise your eyes, meaning eye diseases are almost a certainty as we age. According the National Institutes of Health, while the odds are strongly against you developing a cataract by age 50 (1 in 40), that's not the case at age 70 (4 in 10) or at 80 (7 in 10). It's a similar story for macular degeneration and glaucoma, which combined will affect just 5% of us by age 60, but 43% of us by age 80. Add in a case of dry-eye along the way, and almost all of us will encounter eye care at some point in our lives.

In addition, eye care is making the leap to developing nations, where rising standards of living are increasing the demand for cataract removal systems, ophthalmic pharmaceuticals, and even contact lenses. For years, eye-care firms have extended the useful life of their products by transferring existing technologies to developing markets. We expect this trend to add to the already promising demographics within the U.S. for eye care--mainly the aging population--and to make this industry an overall strong performer.

Is Eye Care Recession-Resistant?
Despite the overall strength of the eye-care business, the current recession has knocked certain eye-care markets off track. As eye care mixes reimbursed and consumer-driven markets, and luxury goods and necessities, the disparities between the various markets can be great. In order to build a recession profile for all eye-care firms, we've listed the four key eye-care markets they compete in, arranged in order from least resilient to the economy to most. After that, we'll discuss our eye-care stocks under coverage, and their exposure to each of these four markets.

LASIK
LASIK surgery is by far the most consumer-driven of all eye-care markets, as the procedure is rarely covered by insurance and requires a large out-of-pocket expense for patients. Although LASIK gives only a short history to draw from, we believe U.S. demand will track closely with consumer sentiment indicators, as patients are unlikely to pay $4,000 to have the surgery if their personal economic future is in doubt. From a near-term peak of 97 for the start of 2007, consumer sentiment readings have plunged to less than 60 recently, and LASIK volumes have followed suit, with a 40% total market decline in the most recent quarter. We expect U.S. LASIK volumes to fall 40%-plus in the fourth quarter this year--25% for all of 2008--and another 15% to 20% next year. Although LASIK volumes will also rise substantially when the economy recovers, we expect a dismal next 12 to 18 months for this market.

Contact Lenses/Disinfecting Solutions
Although contact lens solutions require an out-of-pocket expense for consumers, solution is an absolute necessity for anyone wearing contacts, so we expect market demand to remain strong even in a recession. However, growth for branded contact lens solutions slowed noticeably in the most recent quarter, suggesting that this business isn't entirely immune to economic woes. Although brand-name solutions received a recent boost from the several safety-related product recalls that sent consumers reaching for quality, we believe the recession has reversed this trend, sending consumers back to less-expensive generic brands. We think this will rein in growth somewhat for brand-name lens solutions, but that the overall market will still post gains.

We expect contact lens sales to hold up relatively well during a recession, given that they're a necessity for most people who wear them. However, we think the recession could make growth more difficult for lens manufacturers. While lenses can't be avoided entirely, patients may end up wearing their lenses for longer than prescribed--turning a one-month lens into a two-month lens--to stretch their dollars. In addition, existing patients may resist trading up to more-expensive lens types at their next checkup, such as silicone hydrogels or torics, which have boosted lens sales in recent years. We believe this will force lens manufacturers to rely more on new patients for growth, particularly from overseas markets.

Ophthalmic Pharmaceuticals
Long thought to be completely recession-proof, we've seen signs in the latest quarter of a deceleration in growth for eye drugs, as patients skip office visits and prescription refills to save on copays. However, we believe this will fix itself in time, as sight-threatening eye diseases can only be ignored for so long, and most of these drugs are covered by insurance. Even if the effects linger, we expect this market to remain resilient and post solid growth in the U.S. and overseas.

Cataract Surgery Devices
Cataract surgery devices, such as lens removal systems and intraocular lenses, are perhaps the most resilient of all eye-care products in the face of a tough economy. Not only is the procedure covered by insurance and a necessity for patients, but the market has also been buoyed recently by strong growth overseas and a slew of new products that have increased reimbursement rates in the U.S. We believe this will make the cataract market a strong performer, and we have yet to see any real impact from the recession thus far.

Our Top 5-Star Pick in Eye Care
 Alcon (ACL)
Fair Value Uncertainty Rating: Low | Economic Moat: Wide | 5 Stars
The largest pure eye-care firm in the world, Alcon holds top spots in cataract surgery devices, lens disinfecting solutions, and several pharmaceutical product categories, including anti-infectives, glaucoma, and allergy. Through the first nine months of this year, the firm's $4.8 billion in sales were split among eye care industries as follows: 43% cataract devices, 41% pharmaceuticals, 14% contact lens solutions, and 2% LASIK. As a result, we think Alcon is in great shape to ride out the current recession, with most of its sales deriving from reimbursed markets. In addition, the firm has a net cash position of $1.7 billion, generates more than half its sales overseas, and boasts one of the widest economic moats in our health-care coverage universe. With shares trading down 40% in the last month despite solid earnings, we'd heartily recommend that investors snap up Alcon at 5-star prices.

Other 5-Star Eye-Care Firms
 Cooper Companies (COO)
Fair Value Uncertainty Rating: Medium | Economic Moat: None | 5 Stars
Cooper derives 85% of its revenues from the sale of contact lenses, with the rest from an unrelated women's health-care unit. As a result, we expect the firm's sales growth prospects to remain sound, especially as the firm launches new contact lens products and works to increase its market penetration outside the U.S.

 Advanced Medical Optics (EYE)
Fair Value Uncertainty Rating: Very High | Economic Moat: Narrow | 5 Stars
Definitely not a safe haven, AMO's fortunes are tied to the cyclical LASIK markets. Through the first six months of this year, AMO's $624 million in sales were divided among cataract devices (43%), LASIK per-procedure fees and equipment (38%), and contact lens solutions (19%). While the firm's cataract sales provide stability, AMO's results have suffered recently due to its large exposure to the LASIK markets and slight weakness in its consumer lens solution business. Going forward, we expect AMO's fortunes to rise and fall with health of the overall economy, as it manages its cyclical LASIK business and relatively high debt burden. As a result, we assign the firm our very high uncertainty rating.

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Jeff Viksjo does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.