According to Morningstar, the healthcare sector remains one the most expensive sectors on the ASX with an average price to earnings (P/E) ratio of more than 22. Some investors might find it hard to justify such a high premium when you consider the financial sector is trading at an average of just 13x and offering a dividend yield of close to 6%.
Those same investors will also find it doubly hard to justify the current valuation of Sirtex Medical Limited (ASX: SRX) with the shares trading on a P/E ratio of nearly 47!
Can this be justified or are investors better served by avoiding this richly valued stock?
To get a better insight into Sirtex, here are a few important points the company highlighted when it released its full year results just over six weeks ago:
- One of the most impressive aspects of Sirtex's 2015 results was the magnitude of increases in profits and sales revenues over the previous period. The company was able to deliver revenue growth of more than 36% that resulted in a 69% increase in net profit after tax. Investors should not underestimate how hard it can be to increase sales in an environment where health professionals are often hesitant to try new therapies.
- Sirtex benefited significantly from the lower Australian dollar as the company's extensive operations in Europe and North America provided more than $12 million in foreign currency gains. With the Australian dollar falling even further since Sirtex last reported, it is likely to receive another significant foreign currency gain in FY16.
- The company generated significantly improved operating cash flows and this allowed Sirtex to increase its full year dividend by 43% to 20 cents per share. Pleasingly for shareholders, Sirtex has been able to provide consistently growing dividends over the past five years. Although the yield is less than 0.6% based on the current share price, the growing dividend is an important sign that the company is growing its earnings.
- Sirtex operates in three main geographic markets but its operations in North America are by far the most significant. Nearly 70% of the company's doses are sold in North America and importantly, the number of treatment sites available to give the treatment in this region has increased by nearly 18% over the past 12 months. Another important signal that the company is expecting strong demand in the region is the fact that it recently tripled the manufacturing capacity to meet the future expected demand.
- In order to drive the continued growth and awareness of Sirtex's SIR spheres therapy, its sales and marketing expenditure increased by 32% to $65.1 million in FY15. Although this is a significant proportion of total sales, the increased spend was necessary to drive the awareness in the oncology community about the recently completed SIRFLOX study. Although the initial reaction to these results from investors was negative, it appears that this was more of a case of poor communication on behalf of Sirtex. The results actually showed clinically meaningful and significant improvements in patient outcomes that could support the wider use of its treatments.
- Investors should also be aware there are a number of further clinical trials underway to determine if its SIR spheres can be used to treat cancers in organs other than the liver. Although the results from these trials are not expected for a number of years, any significant results in these trials could be a game changer for the company as the number of markets available for its treatments will significantly increase.
- The FY16 outlook for Sirtex remains positive with the company expecting sales growth to continue in line with its recent historical trend, helped by the new evidence from the SIRFLOX results.
Foolish takeaway
Although the stock appears to be fully valued at current prices, it would not be surprising to see the share price significantly higher in 12 months' time.
It is obvious from the points above that Sirtex is a company that is growing earnings well above the market average and that has the potential to do so for a number of years to come. To put these two points in perspective, Sirtex has increased its earnings per share by nearly 250% over the past five years yet has penetrated less than 2 per cent of the addressable global market.
So while it is hard to buy a stock that is trading on a P/E ratio of 47, in Sirtex's case this could very well be justified.
Five years ago Sirtex had a market capitalisation of just $300 million…
