Medtronic and St. Jude Medical will Outperform this Stock

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In the years ahead, I expect the medical device industry to be challenged by greater competition and higher taxes. However, there are still undervalued stocks out there that can outperform through innovation despite these headwinds. These stocks have low enough multiples and strong free cash flow yields that limit downside, and will encourage investor entry from pipeline developments. Below, I review 3 producers in the field.

Medtronic (NYSE: MDT) Undervalued, Multiple Value Drivers

At a respective 12.4x and 10.6x past and forward earnings, Medtronic is a compelling buy. It offers a 2.5% dividend yield expanding gross margins, which now stand at 75.9%. Free cash flow generation is not only quite strong, but has been heading in the right direction. FCF increased more or less consistently from around $1.8 billion in early 2006 to $4.2 billion today. It now represents a 10.1% yield against the market capitalization--pretty impressive.

Analysts currently expect EPS to grow by 6.7% annually over the next 5 years. This rate is 75 bps higher than what was achieved in the past 5 years and more than within reach. Over the last 5 quarters, the company has performed roughly in-line with consensus.

I am particularly optimistic about the company's Symplicity renal denervation product that helps lower blood pressure. This minimally invasive technology could help answer the woes of over 42 million individuals suffering from hypertension and 76 million Americans with blood pressure over 140/90 mmHg. Domestic trials are currently underway, and the future looks promising in light of 18-month data that showed a sustained drop in blood pressure from otherwise treatment-resistant hypertension patients. Fortunately, Symplicity isn't the only catalyst that Medtronic has going for it. The decision to purchase China Kanghui Holdings for around $820 million provides meaningful emerging market growth opportunities. Products in spine, craniocerebral, and cranial maxillofacial trauma help diversify its market.

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

Boston Scientific just isn't what it used to be. It once was a thriving $60 billion corporation. Although performance has been consistently better than expected over the past 5 quarters, the long-term strategy looks weak. The decision, for example, to acquire Vessix Vascular for $125 million and milestone payments is indicative of weak fundamentals. Vessix is a developer of a renal denervation system that will come under tremendous pressure from Medtronic's product.

After showing some life between 1Q 2011 and 1Q 2012, the company has returned to negative ROA territory. And the weakness has become particularly acute, so I do not encourage buying shares during this low. EPS has fallen to a loss of $2.84 over the TTM, but analysts still expect it to earn $0.43 per share next year. Assuming the company can grow EPS by 8.3% annually, however, the stock is just not undervalued enough compared to Medtronic to merit a "buy."

By contrast, St. Jude Medical provides a meaningful growth play. It trades at a respective 14.9x and 9.9x past and forward earnings. Analysts forecast EPS growing by 10.7% annually over the next half decade Assuming expectations are met, 2016 EPS will come out to $4.89. At a multiple of 15x, this translates to a future stock value of $73.35. Discounting backwards by 10% yields a present value of $45.54, which is at around a 30% premium to the current market cap. My calculation is also in-line with the consensus price target and the most recent (September 2012) price target. This value potential makes St. Jude Medical preferable over 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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