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Covidien: Great Buy, Great Margins

March 02, 2012 | About:
Covidien (COV) reported its first quarter numbers at the end of January which were well received by the market, the shares improving by over 4% on the day of the release and continuing their march upwards since. Having seen the shares rise from $41.35, their 52-week low, in December to today’s price of $52 through the results period, it’s now worth seeing if the shares represent value at this price.

Price to Earnings

With Covidien shares changing hands at $52, the shares trade on a trailing price to earnings ratio of 13.35. This is lower than that of similar-sized healthcare products companies. Baxter International (BAX) shares trade on a price to earnings ratio of 14.68, while Becton Dickinson’s (BDX) trailing price to earnings ratio is 14.13 and Thermo Fischer Scientific’s (TMO) is 16.31.

Covidien’s undiluted GAAP earnings in its latest quarter rose to $1.02 from $0.86 last time. In its result statement, it said that it expects earnings for fiscal 2012 to be in line with market consensus, though it has highlighted a strengthening dollar as a point of concern.

The forward price to earnings rating of Covidien shares at 11.37 is in line with its peers.

Dividend and Yield

Covidien shares, with dividend paid over the last year of $0.90 per share, yield 1.70%.

Baxter shares yield 2.40%, while Thermo shares pay no dividend. Becton’s yield of 2.3% is similar to Baxter’s.

Margins

Profit margin at Covidien, Baxter and Becton all come in at around 16%, (though Covidien’s profit margin is the best at 16.53%) and operating margins at the three competitors stand in the low 20% range. Thermo’s margins are in the low double digits.

Baxter’s return on equity of 32.25% is the highest of the group, and Becton’s return on equity of 25.27% is better than Covidien’s 19.89%.

Revenue and Earnings Performance

Last quarter’s revenue growth at Covidien, as reported on Yahoo Finance, was better than two of its rivals: 4.7% as against 2.7% at Baxter, and 2.5% at Becton. Thermo’s revenue growth, however, at 12.7% is the star.

Covidien, however, has a great handle on its costs, even though they are rising, and was able to post the best earnings growth of the four companies. Indeed, earnings growth came in negative at both Becton and Thermo.

Debt Position

Covidien has the lowest debt/ equity ratio of the four companies. At 43, it is half that of Becton’s, and 50% lower than Baxter’s debt/equity ratio of 63. Covidien has $1.77 billion of cash and $4.4 billion of debt. However, it has pointed out that it has an annual free cash flow of $1.9 billion. Its debt position is not a problem.

Conclusion

Covidien shares, on fundamentals, seem fairly valued overall in comparison to its peers.

It expects its earnings to be in line with market expectations, though it has tempered expectations for net sales growth for the year to around 1-3% from its previous guidance of 3-5% due to the negative effect of the strengthening dollar. Excluding this effect, it has said that it expects sales growth in the region of 3.5%. It believes that operating margin will remain stable at around 22% to 23%, and that a driver for business growth will once more be emerging markets.

Much of its 21% cost hike last quarter was focused on improving marketing and sales in its emerging markets segments, and Covidien now expects double-digit growth in sales here.

Its gross margins rose to 58.7% from 56.7% a year earlier, and this is expected to remain about stable through the year.

The shares are trading toward their 52-week high of $57.65, and having risen by nearly 25% from their low in December there is potential for a pullback. However, this is a well-managed company, targeting marketing and sales expenditure to the important emerging markets while keeping a tight rein on research and development costs. The dividend is well covered by its earnings, and the shares are trading in line with its peers when measured on a forward price to earnings basis. The shares may try to make a new longer term trading range of $50 to $60. Though the strength of the dollar may hold financial results back a little, management has recognized this and flagged it as a concern. I like that honesty up front: It goes hand in hand with great margins, strong cash flow and low debt.

About the author:

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