1 Medical Device Stock to Buy, 2 to Avoid
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In light of the 2.3% excise tax that will hit medical device companies once the Affordable Healthcare Act is implemented, many investors are concerned about whether this has been appropriately factored into the market. Although it's not too well known, its impact will largely be offset by the pipeline of the top producers. While some firms have unreasonable growth prospects, others are taking the right steps to hedge against uncertainty through pharmaceutical partnerships, diversification, and emerging market penetration.
Medtronic (NYSE: MDT) Undervalued on Several Levels...
Although the Street is relatively reserved on Medtronic, in my book, it is a "buy." It trades at a respective 12.8x and 10.9x past and forward earnings with a dividend yield of 2.5%. Forecasts for 6.7% 5-year annual EPS growth are 72 bps greater than what was realized over the past five on an annual basis. And the company is valued at meaningfully less than its historical 5-year average PE multiple of 16.7x.
The company has driven decent free cash flow gains. For the TTM ending April 30, 2010, Medtronic generated $3.6 billion. Two years later, that figure was $4 billion, which is at a healthy 9.3% yield against the current market cap. Fortunately, the company has a series of products under development that will catalyze the bottom-line. The company recently completed the first phase of feasibility studies for its new renal denervation system. What sets this product apart from existing options is that it reduces ablation time during renal denervation treatment.
It also is developing an Alzheimer's pump technology, which it will partner with drug manufacturers to, hopefully, deliver solid efficacy. This technology pushes therapeutics directly to the brain, which sounds scary but may be the quickest way to at least slowing the progression of this form of dementia. Currently, 36 million individuals in the United States suffer from dementia, and they don't have a cure available. The market potential to effectively deliver the best solution to patients is significant and, in my view, under-appreciated by the market.
I am also optimistic about the firm's recent decision to purchase China Kanghui Holdings for $816 million in cash, which exposes the firm to high growth emerging markets. This company produces orthopedic implants in China and will provide Medtronic with a better value segment distribution network to drive synergistic value.
Compared to Medtronic, Boston Scientific and St. Jude Medical are unattractive picks. For one, analysts currently rate the former closer to a "sell" than a "buy," yet forecast a major turnaround that I do not believe is in the works. Over the twelve trailing months, the company lost $2.27. Analysts, however, foresee this reversing to a $0.45 EPS next year. This sets the bar high for disappointing negative earnings misses.
While Boston Scientific beat EPS expectations by $0.05 through generating $0.16 per share in profit, revenue declined 7% y-o-y and came in below expectations by $20 million. Although the gain in margins may be attractive, I want to see sales growth in the companies that I back, since ultimately this is what makes up market share. If you can have a low margin business with more revenue, that is much better than having a high margin business with less revenue, assuming profit is equivalent. Connections with more customers will help to sustain future streams of free cash flow.
As for St. Jude Medical, specifically, I am concerned about the FDA inspecting one of its manufacturing facilities of defibrillators and pacemakers. Past insulation problems with defibrillators have already left a bad smell; repeating history would, of course, only make the situation worse. Operations have also been more or less weak. The top-line in 3Q12 fell 4% sequentially from the same quarter last year as operations were closed in Sweden and management "streamline[d]" operations". Perhaps most disconcerting, domestic sales of pacemakers fell 10% and international sales fell 8%. FX headwinds only further clouded the turnaround story, especially in light of flat margins.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Medtronic and St. Jude Medical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.