Medical Device Stock Roundup: Avoid 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.

Though the Affordable Care Act will implement a 2.3% medical device tax starting next year, producers of these technologies still have promising potential. I particularly recommend looking at their catalysts, takeover activity, and existing businesses before making an investment decision. Below, I review 3 stocks with these variables in mind.

Baxter International (NYSE: BAX) Vs. Covidien (NYSE: COV)

Baxter trades at a respective 15.8x and 13.4x past and forward earnings, which compares poorly against corresponding figures of 14.8x and 12x for peer company Covidien. But analysts forecast Bacter's EPS growing by 9% annually over the next 5 years. This is on the fence of making the stock undervalued in light of the historical 5-year average PE multiple of 17.3x. Moreover, with a return on invested capital of 20% (690 bps higher than the industry average), the company is creating significant value.

Going forward, there are several reasons to be optimistic about Baxter. I like the company's recent decision to acquire Gambro in a major $4 billion deal - the largest yet for Baxter. This dramatically increases the device maker's exposure to dialysis products and will, according to Baxter's estimates, generate $300 million a year in synergies by 2017. And I also believe that hemophilia drug Advate holds up well against Biogen's, particularly since the latter is strongest in treating abrupt bleeding, which accounts for just one-fourth of Advate's domestic sales. Moreover, patients are often unwilling to switch drugs, so Advate has a strong early-mover advantage.

The 34% dividend hike and $2 billion share repurchase program in mid-June also showcase management's confidence about the fundamentals. On the other hand, the company has seen negative catalysts in recent months. For example, the FDA has delayed approval of HyQ and is seeking more preclinical data to see how the candidate effects development, fertility, and reproduction. FX headwinds are also cutting into the bottom line.

So what about Covidien then? This Irish producer was recently rated a "hold" by Stifel Nicolaus. It is forecasted for 9.3% annual EPS growth over the next 5 years, so it will largely be benchmarked against Baxter. If the company continues to beat analyst expectations, I believe multiples will eventually expand to peer levels. In the twelve trailing months ending 3Q 2012, Covidien generated $1.9 billion in free cash flow for a yield of 6.9%.

Why You Should Buy Cryolife (NYSE: CRY)

For greater upside, you should consider buying smaller cap stocks. Cryolife trades at a respective 21.1x and 19.1x past and forward earnings, and has a very clean balance sheet with no debt. It can be easily bought out by a larger peer, and it has several good reasons to be bought out.

Shares have, after all, risen ~50% YTD for a reason. In addition to developing medical devices for vascular and cardiac applications, Cryolife is positioned in the high-growth market for human tissue transplantation. Its BioFoam® Surgical Matrix protein hydrogel technology seals organs and is a potential game changer. This foam acts as a mechanical barrier that reduces blood flow, which leads to cellular aggregation. Right now, the technology is only approved for only investigational use through an IDE. This will enable the company to enter clinical trials in the US to gauge efficacy and safety in sealing liver parenchymal tissue.

At the same time, the existing business has come out better-than-expected. Third quarter EPS of $0.08 beat consensus by 50% Certainly, managements issuance of a first-ever quarterly dividend at a yield of 1.9% has helped showcase confidence over the fundamentals. This is a strong company with a promising a product available at a low price.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Covidien Ltd.. 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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