Here are some key points showing why the stock is a long-term buy.
The company is a growth medical technology stock with diversified products. Despite the revenue decline in the U.S. market, it has steadily increased its revenues through expansions in the international market, innovative and diversifying into product lines and acquisitions. It generates steady cash flow which will finance growth in the future.
New products launch and acquisitions will be the key driver to growth. Medtronic's product line is wide and promising. With continuous investment on R&D, the company is able to introduce various new products in the market. It launched a cardiac surgery product with Miami Instrument, Endurant II AAA Stent Graft system and remote glucose meter, among others. The majority of its products have a high rate of approval from the U.S. Food and Drug Administration.
It also made several recent acquisitions to maintain its leading position in medical equipments industry: the Salient Surgical and PEAK Surgical Inc. acquisition to widen Medtronic's surgical technologies’ portfolio and the Ardian Inc. acquisition to increase its revenue.
With these innovative products and acquisitions of new technologies, Medtronic is expected to drive its steady revenue growth. It has taken many steps for further expansion in international markets, particularly emerging markets which would help to support company growth in future.
Steady sales growth and cost reduction will improve margin and profitability.
For the past five years, Medtronic has been able to grow in the 7-9% range. After poor performance in sales in 2011, it was able to turnaround in the first half of 2012 with revenue growth of 6.57%. Revenue growth was driven mainly by international sales with 6.79% growth. However, U.S. sales were still under pressure and declined 1.18% in first half year 2012. With further expansion in international business, I expect the same kind of revenue growth on the second half of 2012.
It has taken various steps to reduce various cost expenses including lower cost of goods sold while maintaining its R&D expenses in line with revenue growth. Consolidation of operations into two operating segments also helped to reduce expenses and thus helped the company to improve its operating margin in the last one to two years (i.e., around 29% in 2011 and 2010). This year the company further improved its margin above 31% in the first half of the year. I expect Medtronic to maintain its operating margin well above 30% this year and next year. This will help to improve profitability and net income going forward.
Improved profit margin, EPS forecast in line with company estimates. With steady growth in revenue and cost reduction measure, Medtronic was able to improve its net profit margin (20.68% in first half year 2012 vs 18.13% for same time period in 2011). With improved profit margins, the company saw more than 24% growth in EPS for first half of 2012 ($1.60 in 2012 versus $1.29 in 2011 for the first half of the year). I expect further improvement in profit margin in the second half year and my earnings per share estimate for 2012 is $3.42, in line with the company's earnings per share estimates of $3.43 to $3.50.
We have compared Medtronic with the following companies:
- Boston Scientific (BSX): a worldwide developer and distributor of medical devices. Its products are used in a range of intervention-oriented medical specialties. The majority of its sales come from its CRM business and Cardiovascular Group. It has $7.62 billion in sales and net profit of $440 million. This translates to an operating profit margin of 13.57%. Its shares trade at 20 times earnings. The stock is rated neutral from analysts.
- St. Jude Medical Inc. (STJ) develops and manufactures cardiovascular medical devices for cardio rhythm management. It has sales of $5.61 billion and operating profit of $1.72 billion. This translates to a net profit of $860 million. Shares have a price earnings ratio of 16 times and carry a dividend yield of 2%. The stock is rated buy.
- Stryker Corporation (SYK) is a medical technology company that provides orthopaedic implants. The company has two segments: Orthopedic Implants and Medsurg Equipment. It has sales of $8.31 billion and net profit of $1.34 billion. It shares currently trades at 16 times earnings and has a dividend yield of 1.60%. The stock is rated buy.
- Johnson & Johnson (JNJ) is a holding company in the health care space. It also has an operating segment catering to the medical devices and diagnostics industry. It earned sales of $65 billion and net profit of $9.67 billion. Its shares are currently trading at 19 times earnings and carry a dividend yield of 3.50%.
At the current price, the shares of Medtronics Inc. are trading at a discount to its peers'. I believe that the discount is unwarranted given the better profitability profile of the company. If you look at the table below, this shows that the company has superior profitability and margins relative to its peers. Also it has good track record of allocating the capital very well. This guarantees that growth will be higher in the future.
Table 1: Comparison of Medical Devices Stocks
|Net Revenue||EBITDA||EBITDA Margin %||Net Income||EPS||P/E||P/S||Div. Yield %|
|Boston Scientific Corporation||7.62||1.75||13.57%||0.44||0.29||20.45||1.13||NA|
|St. Jude Medical Inc.||5.61||1.72||25.36%||0.86||2.64||16.20||2.44||2.0%|
|Johnson & Johnson||65.03||19.24||24.84%||9.67||3.49||18.51||2.71||3.50%|
Strong Financial Position and Higher Operating Cash Flow
The company has strong financials with positive and increasing cash flow of $3-4 billion a year. It also has enough cash to withstand the current stressed environment. Its debt to equity ratio is also in the range of 0.5. With improving operating margin we expect cash flow to further grow with no major changes in key ratios. From these ratios, we can say that there is enough flexibility for the company to execute its expansion plans.
Medtronic has shown steady growth in its revenue in the past. We expect this growth rate to remain because of its diversified products pipeline along with recent acquisitions. Also it faces a long-term headwind of increasing demand for healthcare.
All of these point to higher cash flow and profitability for the company. Its shares are also trading cheap compared to peers, which makes it an attractive investment for conservative investors.
About the author:
I fundamentally analyze every business from the top down.
In my personal life, I have a strong Jewish faith and enjoy playing Scrabble and entrepreneurship.