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Wednesday, July 12, 2006

‘No Place Like Home’ in Biotech Stocks, Part 2: Candela Corp. (CLZR)

Saul Sterman submits: The first installment of this five part analysis covered Syneron Medical (ELOS). The second part deals with Candela Corp. (CLZR), our second favorite of the five competitors.

First, here’s a quick synopsis of the series in its entirety:

Syneron Medical (ELOS) – designs, develops and markets aesthetic medical products currently relying heavily on FotoFacial RF skin treatment and developing a dental laser line of products.

Candela Corp. (CLZR) – designs, develops and manufactures aesthetic laser systems currently replacing the VBeam system with the more advanced Pulsed Dye Laser (PDL) Platform.

Cutera (CUTR) - designs, develops and manufactures aesthetic laser systems and other light-based equipment.

Laserscope (LSCP) – designs, develops and manufactures surgical and aesthetic laser systems and related surgical equipment.

Palomar Medical Technologies (PMTI) – researches and develops laser systems primarily for hair removal and to a lesser extent other cosmetic applications.

Our outlook on the medical equipment sector is for the most part neutral with the notable exception being the cosmetic surgery stocks. Contrary to the over supply situation that prevails in the cardiology, orthopedics and drug-eluting coronary stents categories, robust demand for cosmetic surgery – primarily facial aesthetics and breast enhancement – should yield excellent returns well into 2007.

And now for our feature presentation…

Candela Corp. (CLZR) has about 300 employees. There has been a noticeable up tick in R&D spending in the last quarter. We are not sure what to make of this nor do we know precisely where and what is under development. classifies Candela as a growth stock.

Rich Duprey at the Motley Fool owns shares and holds Candela as a long term investment.

Going strictly by the numbers both Forbes and Rich Duprey seem to be on target. As surmised from Candela’s income statement, both revenue and profits appear to be growing at a fast pace for the past two quarters. In addition Candela was never subject to the patent infringement lawsuit brought (and since settled) by Palomar against Cutera.

A closer look reveals a slightly different picture. Candela has done an excellent job in reducing cost of goods sold. When comparing Q2 2005 with Q1 2006, revenue and COG were 38.6 M$ verses 42.3 M$ and 20.6 M$ verses 20.9 M$ respectively. The additional 3.6 M$ in operating income for Q1 2006 is directly related to lower manufacturing costs.

Our analysis leads us to conclude that this lower cost base is factored in. EPS growth can come from only one source and that is sales growth. Further meaningful reduction in manufacturing costs is unlikely especially in the wake of rising raw material costs.

On the sales front Candela is lucky to be in a sector benefiting from a 20% annual growth pattern. The competition is fierce and we don’t see the new product line having a noticeable advantage over Palomar or Syneron systems. Candela doesn’t have home/self apply devices in the pipeline. Performance will come down to marketing. It appears that Syneron Medical (ELOS) has a head start in both expanding marketing efforts of clinical systems and the development of home treatment devices. Taking all of the above into account, Candela has 9,000 systems installed worldwide compared to Syneron’s 4,000. This should give Candela some economy of scale muscle.

The market has priced the stock at 20 to 25 times forward PE taking into account a 14% growth rate for the next five years. This is about right. Should revenue veer from the 14% growth expectation the stock will move (up or down) accordingly.

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