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Stock Strategist

Growing Healthcare IT Demand Benefits Cerner

Although revenue issues continue, we think the shares are undervalued.

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Although  Cerner's (CERN) fourth-quarter results met our expectations, we've lowered our fair value estimate to $63 per share from $69. The management team once again missed its own revenue guidance, and we believe the firm is experiencing increasing pressure in its operating environment. Considering these latest developments, we now believe top-line growth will moderate slightly faster than we initially expected. Additionally, we believe competition from current and new healthcare information technology players has accelerated, given the growing need of providers to build in new reimbursement infrastructure and the prime opportunity this presents to the entire healthcare IT market. As a result, we believe Cerner will see greater sales and research and development expenses over the medium term than we initially expected. These modeling adjustments lead to a reduction in our explicit forecast revenue growth and operating margin expansion assumptions. Nevertheless, the stock trades below our reduced fair value estimate, presenting investors with an opportunity to acquire shares of a solid healthcare firm at a material discount.

We are highly disappointed that management has missed its own revenue guidance over the past several quarters. We believe management's missteps have built in an increased level of uncertainty for the firm. We will watch closely how this trend develops over the coming quarters and expect the missed guidance pattern to reverse over the course of 2016. We believe this issue points to a shift among Cerner's customer base as hospitals and medical service providers are now demanding greater value from their healthcare IT vendors. Additionally, we believe new entrants like UnitedHealth and traditional rivals such as Epic Systems have increased their sales efforts and are now willing to accept less advantageous payment terms. The confluence of these factors has caused Cerner to experience a delay in revenue growth and margin expansion.

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