Cosmetic-Services Stocks Pretty Up

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Earnings, stocks, and economic data are all pointing in the same direction -- toward a recovery with some real momentum. Finally. So, many Americans might be feeling flush and ready to splurge again. And to more than a few, that might mean a little dental work or cosmetic surgery is in order.

Cosmetic procedures usually aren't covered by health insurers, so when the economy is sluggish and job security uncertain, it's easy for people to put them off. But now that growth has perked up, a rebound in demand for these services could materialize. Vision-correction surgery has declined over the last several years but is expected to increase next year. Breast augmentation, injections of collagen and wrinkle-smoother Botox, teeth whitening or straightening, and other dental and orthodontic procedures also are expected to be on the upswing.

"When people's outlook on the world is positive, they say: I'm going to do this really special thing for myself," says Liz Davila, chief executive of Visx (EYE), the country's biggest provider of lasers used in vision-correction surgery.

WRINKLE FILLER. Investors and analysts single out several companies as the most likely beneficiaries of this pent-up demand. Already, some of their stocks have run up considerably on expectations of a strong 2004. But some of them still have room to grow, experts say. And new products and innovations should also help expand revenues and earnings.

For one, Medicis Pharmaceutical (MRX) last week received approval for a new wrinkle-filling product called Restylane, while Inamed (IMDC) in Santa Barbara, Calif., will likely be selling silicon breast implants upon expected Food & Drug Administration approval in coming months. This year, Visx (EYE) introduced a new, more expensive custom vision-correction procedure. Shares in Inamed and Visx are up more than 100% year-to-date, while Medicis stock has gained about 40%.

"Now that we're seeing fourth-quarter signals on the economy that are mostly positive, people will become more confident of economic recovery, and you'll see more upside on most of these stocks," predicts Weidong Huang, vice-president of New York-based Times Square Asset Management. (Huang owns shares in LCA Vision (LCAV).) Moreover, he points out that these businesses have significant operating leverage, which means their profit margins are likely to rise faster than revenues because fixed costs don't change much as sales rise.

SEEING GAINS. Visx, for one, is expecting 60% earnings growth in 2004, though revenue should expand in the high teens. It reported earnings of $15 million on $140 million in revenues in 2002. Davila says ophthalmologists have been booking more procedures for the new year than in recent years. A new custom procedure will also help the top line in 2004, probably accelerating growth: Visx receives a $235 payment for each custom procedure, vs. $100 per traditional correction.

In November, the higher-priced custom procedures accounted for only 10% of total sales, but Davila sees that rising to 30% next year. Michael Lachman, analyst at ThinkEquity, says Visx' valuation of 32 times 2004 earnings is only slightly higher than its historical average of 30. He has a price target of $29 on the stock, which would be up 22% from the current price of $23 and change. (Lachman doesn't own shares. His firm has no relationship with Visx.)

Smaller concerns that should benefit from better vision care include LCA Vision, which runs vision-correction centers and has just raised $37 million in a secondary stock offering. "They now have money to build new facilities," says Allen Klee, fund manager at First Investors, noting that few other chains are currently expanding. (Klee's fund owns shares of LCA Vision and Visx.)

Contact-lens supplier 1-800 Contacts (CTAC) also seems likely to benefit as sales of weekly and daily lenses pick up in the improving economy. Huang figures many people have been making do with once-monthly or tri-monthly lenses.

GOLD IN PEARLY WHITES. Aligntech (ALGN) seems poised for more impressive growth as well. In recent years, its dental-realignment product, Invisalign, has made straightening crooked teeth a less daunting proposition for teens and adults, and orthodontists have been increasingly receptive to its product. Aligntech reported its first operating profits in the most recent quarter.

The outfit should grow 60% in 2004, says Brandon Carl, health-care analyst at BB&T Asset Management. He figures that consumers are feeling more inclined to pay the $500 to $600 more for Invisalign than traditional braces, which cost about $4,500. The stock, he says, is attractive if it were to pull back to $15 per share, from its current price of about $17. "Improvement in the economy has played a large role" in its rising earnings, Carl says.

Dental suppliers, by that logic, should also have a good year. That's because people tend to schedule more dental procedures, only about half the cost of which are covered by insurance, when the economy strengthens. Of the two big players -- Patterson (PDCO) and Henry Schein (HSIC), analysts say the latter seems the better buy. In the past, Schein has always been considered the lower-quality name, Huang says. But lately, under new management, it has been taking market share from Patterson and beating earnings expectations, while Patterson has recently missed forecasts. Schein's valuation of 19 times next year's earnings, however, is lower than Patterson's p-e of 25.

FIGHTING AGE. To John Zielinski, portfolio manager at Neuberger Berman Century Fund, the economy isn't the only good reason to own shares in these concerns. As baby boomers age, their willingness to spend on products to fight the effects of growing old is unmatched by any previous generation, Zielinski says. On that thesis, his fund holds shares in Patterson as well as Zimmer (ZMH) and Stryker (SYK) -- makers of replacement joints.

Over the longer term, demographic trends may also drive Botox sales as much, if not more, than a buoyant economy. Botox use "started to ramp up even before [the economy] started to turn," Carl says, noting that a modest rebound should help increase demand. Carl says Allergan (AGN) is well diversified, with a third of its business in Botox and the remainder in generic drugs.

Of the two biggest suppliers to plastic surgeons, Inamed and Mentor (MNT) should both see rising demand. However, despite Inamed's massive rally this year, Huang expects it to continue rising while Mentor shares struggle. That's because Mentor continues to trail Inamed in new products. Contends Huang: "If Mentor gets its act together, it should grow along with Inamed."

After all, people tighten their belts in a tough economy, but when times are flush, a little cosmetic nip and tuck often becomes more of a priority.