8 Stocks Fit for Contrarian Investors

BREAST IMPLANTS CAN defy gravity and genetics, but not a sagging economy. Since most augmentation surgeries are what doctors call elective and economists call consumer discretionary, demand for them, like for restaurant meals and theme park visits, has slowed of late.

That has sent shares of Santa Barbara, Calif.-based Mentor (MNT), America's leading supplier of breast implants, to $24 from $40 this year. (They're up 39%, vs. 27% for the S&P 500 index, since this column first recommended them in July 2003.) The decline earned Mentor a spot on a recent contrarian stock screen, which looks for companies whose shares are moving in the wrong direction but now look cheap.

The past decade has seen a boom in busts; U.S. augmentations numbered 399,440 last year, up from 101,176 in 1997, according to the American Society for Aesthetic Plastic Surgery. That's a compounded yearly growth rate of 14.7%, vs. 8% for all plastic surgery procedures. Last year, however, surgeons installed just 4.1% more breast implants than the year before. Wall Street analysts expect a 5% decline this year.

Considering the trend, Mentor's sales have held up nicely, improving 10% in the company's first fiscal quarter ended June 27, or 4% excluding the July 2007 acquisition of Perouse Plastie, a French breast implant maker. Three factors helped. First, about a fifth of implant sales are for the reconstruction of breasts lost, most notably, to cancer. Such procedures are often covered by insurance, and so are less prone to a weak economy than augmentations.

Second, patients are increasingly opting for silicone over saline. In November 2006 the Food and Drug Administration ended a 14-year ban on silicone implants, leaving Mentor and Irvine, Calif.-based Allergan (AGN) with a domestic duopoly. (Allergan in April 2006 bought implant maker Inamed for $3.1 billion, about 80% more than it went for when this column recommended its stock in December 2003.) Silicone implants can cause more complications in cases of ruptures but also look more like real breasts. They also cost twice as much. So the ongoing shift in demand toward silicone is helping sales, even if volumes are stagnant or slipping. Analysts forecast a two-thirds share for silicone in the U.S. by 2010, up from 45% today but below its 80% share outside the U.S.

A third factor helping Mentor: About 30% of sales come from outside the U.S., where the company says business has been strong. This has a drawback, though. The absence of a silicone ban overseas has led to far more competition for smaller profits; witness the July 2007 bankruptcy of Las Vegas-based Medicor, a maker of breast implants for overseas sale. So a shift to exported implants doesn't flatter Mentor's margins. Its 4% organic sales gain in the first quarter was accompanied by a mere 2% improvement in gross profit. Higher selling costs drove operating profit down 21%. A sharp drawdown of interest-earning cash and securities reduced net profit by 31%, although the funds were spent largely to retire shares, resulting in a muted earnings per share decline of 17%.

Long-term trends for breast implants seem, fiscally speaking at least, promising. The nearly three million implants installed over the past decade, combined with the tendency of implants to need replacing after a decade or so, suggests a fertile market for saline-to-silicone upgrades. And while breast implants make up 89% of Mentor's sales, its facial products hold ample growth potential. In March the FDA approved Prevelle Silk, developed by Genzyme (GENZ), which Mentor will market. It's an injectable gel combined with lidocaine to temporarily plump away wrinkles while relieving the pain of the procedure. Mentor expects to launch a second so-called dermal filler later this year and is working toward winning regulatory approval in 2010 for its botulinum toxin, a highly poisonous protein that, injected in minute doses, reduces the appearance of wrinkles. Allergan markets a botulinum toxin under the brand Botox. Botox injections are the most common cosmetic procedure, with more than 2.7 million performed last year.

All told, analysts foresee Mentor's earnings dipping 1% this fiscal year, which runs through March, but rising 20% next year. That makes shares seem reasonably priced at less than 19 times forecast earnings for this fiscal year. The stock carries a dividend yield of 3%.

Have a look at all eight contrarian screen survivors if you like or run the search for yourself using SmartMoney's stock screener and the full list of search criteria.

Also See: