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Value Thoughts — Medtronic Inc.

May 31, 2011 | About:
wax

wax

Author's Website
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Medtronic Inc. (MDT) is a global leader in medical technology that helps to alleviate pain, restore health and extend life for millions of people.

The company was founded in 1949 and incorporated in Minnesota in 1957. Today the company serves physicians, clinicians and patients in more than 120 countries worldwide and functions in seven operating segments that manufacture and sell device-based medical therapies.

These operating segments are cardiac rhythm disease management, spinal, cardiovascular, neuromodulation, diabetes, surgical technologies, and physio-control. The company's primary customers include hospitals, clinics, third party healthcare providers, distributors and other institutions, including governmental healthcare programs and group purchasing organizations.

Basis

Financial information presented in this report for Medtronic Inc., is based on the company’s most recent SEC Form 10-K filing for year ending April 30, 2010, as filed with the Securities and Exchange Commission on June 29, 2010.

Liquidity

Both the company’s current ratio at 1.92, and quick ratio at 1.39, are below what we consider investment quality, while the company’s cash ratio at 0.74, slightly exceeds our investment quality threshold. Additionally, the company’s goodwill and intangibles comprise almost 40% of the company’s total assets, well above our 15% investment quality threshold.

Profitability

The company’s FY10 gross margin was almost 82%, its operating margin was almost 33.5%, its net margin (NOPAT) was almost 28%, and its return on invested capital was just short of 33%.

The company’s FY10 effective tax rate was almost 22%, while for prior tax years its effective tax rate was 23% for FY 2008 and 23% for FY 2009. With an average effective corporate tax rate at between 28%-35%, we think a better understanding of the company’s effective tax results is warranted prior to considering the company for investment.

Debt

The company increased its total debt during FY10, from $7.3 billion to $9.5 billion, an almost 30% increase. Not surprisingly, we believe the company’s debt level far exceeds its earnings capability and is gaining little for the additional debt management it's adding to the company’s balance sheet.

We simply do not see FY 2011 earnings being much improved over FY 2010 earnings even though the company spent $620 million on acquisitions during FY 2010, not including providing an avenue for an additional spend of $150 million.

We see FY 2010 acquisition spending much the same as FY 2009 spending, a year in which the company spent approximately $1.25 billion during on acquisitions that lead to an increase in FY 2010 total debt of 30% and an increase in FY 2010 earnings of 6%.

Cash

The company ended FY 2010 with $1.4 billion in cash and $2.375 in marketable securities, putting available cash at $3.40 per share. In addition, the company had operating cash flow for FY 2010 of $5.05 per share, a year-over-year increase of 2%, generated free cash flow of $3.66 per share, a year-over-year increase of 2%, and increased their annual dividend by 9%, from $0.75 in FY09 to $0.82 in FY 2010.

Short-Term Investment

The stock closed recently at $40.31, with first resistance at $40.66, a 1% increase from the recent close, second resistance at $43.33, a 7% increase from the recent close, and first support at $37.07, an 8% decline from a recent close, and second support at $30.80, a 24% decline from the recent close.

With a relative strength indicator near 40, we assumed the stock would be setting up for a jump in price. However, the stock price seems to us to be vacillating, with no real movement up or down. Since we believe there is currently greater downward price volatility, we have no short-term interest in this stock at the present time.

Earnings Growth Investment

Our earnings growth valuations are based on the spread between year-over-year earnings growth and the current PE.

In the case of Medtronic Inc., the company had year-over-year earnings growth of 6%, ending FY 2010 with earnings of $3.99 per share. With a current PE of 10, the spread between earnings growth and the PE is about 0.6, meaning that for an investor focusing on earnings growth, a current fair value for the stock is about $43.00, a $2.39 increase from a recent close.

Long-Term (Five-Year Hold) Investment Valuation

Based on our review of the company’s latest annual financial information we think a reasonable value estimate for the company is in the $43-$44 range. Assuming all due diligence was performed prior, we would set a buy target at about $26, a first sell target at about $51, and a close target at about $54.

In addition, based on our assessment of the company financial information that we reviewed, we believe a reasonable financial risk multiplier is 54. Accordingly, for the more risk averse value investor, we think a reasonable buy target is in the $14-$16 range.

Final Thoughts

Considering a recent close of $40.31, the financial information that we reviewed, an estimated merger and acquisition payback of 9.3 years (assuming EBITDA remains the same), year-over-year earnings growth of 2%, as well as year-over-year free cash flow growth of 2%, we think the stock is currently fairly valued, and not a candidate for the Wax Ink Portfolio.

Disclaimer

We have no position in Medtronic Inc. and no plans to initiate a position in the next 72 hours. Additionally, we have received no compensation to write about a specific stock, sector or theme.

About the author:

wax
Wax Ink is a baseline equity research company not licensed or registered with any government agency

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Rating: 2.5/5 (10 votes)

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