2 Medical Device Stocks To Buy, 1 To Avoid

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If you are interested in the medical device industry, there are a few stocks that are likely to outperform the market. These stocks have shown promising data results in clinical trials and are not overshadowed by poor demand. In fact, they are being buoyed by signs of growing demand and penetration into large markets. With this in mind, I review three medical device producers below.

Excellent Fundamentals Undervalue Medtronic (NYSE: MDT)

Although Medtronic is near its 52-week high, having gained 30.3% from the 52-week low, it is still at a compelling valuation. It trades at a respective 12.8x and 11x past and forward earnings, with a dividend yield of 2.5%. Having grown EPS by 6% annually over the past 5 years, the stock may not seem like a top growth play. However, I find that it is still meaningfully undervalued and has excellent fundamentals.

Gross margins and operating margins have increased to 75.9% and 25.9%, respectively. Over the last 5 quarters, Medtronic has performed either in-line with or better than expectations. In 1Q 2013, pricing fell 3% in domestic ICDs but was offset by implant volume growth of 4%. The domestic spine market was flat, but new products and procedures are picking up momentum. For example, management has noted how POWEREASE has attracted greater surgeon interest. International growth has also been strong at 6% in the first quarter, driven largely a 14% gain in emerging markets. With management committed to returning 50% of free cash flow to shareholders, the company is relatively safe from downside. During the last half decade, over 13% of shares have been repurchased and the dividend has more than doubled.

Going forward, I am quite optimistic about the company's Symplicity product, which controls high blood pressure. The device is a minimally invasive renal denervation process that consists of radiofrequency ablation and a steerable catheter being inserted into a renal artery. With over 42 million individuals taking drugs to treat hypertension and 76 million Americans having blood pressure, the market potential is huge. While Symplicity has been approved in Europe, it is currently undergoing trials domestically. 18-month data has demonstrated that Symplicity can produce a sustained drop in blood pressure for treatment-resistant hypertension patients. Results for a 532-patient study will be released next year, but the FDA most likely won't render a decision until 2015.

Avoid Boston Scientific (NYSE: BSX), Buy St. Jude Medical (NYSE: STJ)

I advise avoiding Boston Scientific, which has seen earnings worsen in recent months. $2.88 per share was lost over the twelve trailing months, and analysts now rate the stock closer to a "sell" than a "buy." By contrast, St. Jude has grown earnings by 11.4% annually over the past 5 years and trades at 10.8x forward earnings. Revenue fell 5% in the recent quarter, but EPS held steady due to improving gross margins.

Assuming St. Jude meets expectations, 2016 EPS will come out to $4.86. At a multiple of 16x, this translates to a future stock value of $77.76. Discounting backwards by 10% yields a present value figure of $48.28, which is at a 25% premium to the current market assessment. Coupled with a 2.4% dividend yield and 22% less volatility than the broader market, St. Jude represents a compelling investment.

Boston Scientific's fundamentals, however, are being challenged. Michael Mahooney recently took over as CEO after leaving a successful career at Johnson & Johnson. And while I am confident that his contribution will be helpful, I see more headwinds than tailwinds for the medical device producer. The heart rhythm and stent market, for example, has been weak and resulted in an $809 million goodwill impairment charge from lower demand.

St. Jude, on the other hand, has delivered stronger results and shown greater momentum in its pipeline. Its Enlightn renal denervation procedure has demonstrated an average 28 point reduction in systolic blood pressure after 30 days, and maintained around that a month later.

All things considered, St. Jude is a preferable investment over Boston Scientific. From greater business momentum to an attractive pipeline, there's more upside. In addition, it doesn't have as great of downside by virtue of not being in turnaround mode like Boston Scientific.

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.

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