Medical device and equipment makers are in the fortunate position of being in a constantly growing and evolving market. The demand for products is limited only by the ability of the end user to pay for the product. In times of economic downturn, less elective surgeries are performed but necessary procedures never go out of style. In addition, the device and equipment industry will be subject to the same retractions in business as any other industries as a result of macro-economic factors. The keys to survival in most cases are the quality of products, cost controls and the ability to forecast the potential needs of end users in certain markets.
Medtronic got its start in 1949 as a medical equipment repair shop and evolved to a company that develops and manufactures technologies for the human body such as radio frequency therapies, mechanical devices, drug and biologic delivery devices and diagnostic tools. After first developing external pacemakers and implanted pace making devices, the company focused on prosthetic and electronic surgical equipment realizing that technological innovation has to be balanced with cost effectiveness in order to achieve long term success. Medtronic has 250 manufacturing facilities that serve customers and patients in 120 countries. Medtronic states that its success and longevity is due to strict quality control, strategy, innovation and working with governments, agencies and peers worldwide on issues of regulatory approvals, reimbursement and cost-benefit analysis.
Medtronic’s common shares trade around $38, have a 52 week range of $43.33 and $30.18. It has a price earnings multiple of 11:85, earnings per share of $3.18 and a dividend yield of 2.60%. The company has total cash of $2.34 billion and total debt of $10.22 billion. The book value per share is $16.28. Market cap is $39.72 billion.
Results for the third quarter of 2012 have Medtronic showing International revenue of $1.773 billion, an increase of 6% over the same period in 2011. Earnings per share for the quarter were $0.88. Revenues for the third quarter were $3.918 billion compared to $3.857 billion in the third quarter of 2011. Third quarter net earnings were $935 million an increase of 1% over the same period in the previous year. International sales accounted for 45% of the company’s revenues in the third quarter. Emerging market revenue increased 15% to $395 million. Revenues from the cardiovascular group and restorative therapies each increased 1% in the third quarter. Restorative therapies such as spine revenues declined 10%, neuro-modulation increased 4% and diabetes revenue grew 8% in the third quarter of 2012 as compared to the same period in 2011. Surgical technologies revenues grew by 22% as compared to the same period of 2011.
Medtronic issued guidance for fiscal 2012 forecasting earnings per share in the $3.44 to $3.47. The Company expects earnings per share growth to be in the range of 7% to 8% for 2012. The company added new products across all of its market segments and acquired the Ardian group a private developer of catheter based therapies for $800 million cash and additional cash payments through 2015. Medtronic announced The company increased R&D spending in the quarter, investing in emerging markets. Guidance for 2012 indicate that total company sales will increase 3% to 5% in fiscal 2012.
Medtronic’s business has been affected by the weak global economy which in turn has accounted for governments cutting healthcare spending. Sales of its two leading products, implantable heart defibrillators and spine products have been weak. The company has stated that the continued decline in the sales of these products is not sustainable and Medtronic “urgently” needs to see signs of improvement. A solution to this problem may or may not involve selling these business segments. The company has also stated that it hopes to revive the company’s growth by expanding internationally and improving returns from research spending. Part of the strategy is to explore making smaller acquisitions and the selling of the external defibrillator business. The company has also experienced slow growth in sales as a result of a study linking improperly used heart devices and researching hiding serious complications with the company’s bone growth product. The company said that it expects fallout from these problems to persist in 2012.
Medtronic’s closest competitor is Covidien, which became a standalone public heath care company when it was spun out of Tyco (TYC) in 2007. Covidien operates in the endo-mechanical products, energy devices, respirator and monitoring products, soft tissue repair products, vascular products, pharmaceutical and medical supply markets. Covidien has manufacturing facilities in 16 different countries and sales personnel in 65 countries. Like Medtronic, 45% of Covidien’s sales are derived from markets outside the U.S.
Covidien’s common stock trades around $52 and has a 52 week range of $57.65 and $41.35. The price earnings ratio is 13:37. Earnings per share are $3.92 and its dividend yield is 1.70%. The company has total cash of $1.77 billion and total debt of $4.42 billion. Its book value per share is $21.21.
Covidien’s first quarter 2012 results indicate that net sales are up 5% at $2.9 billion compared to $2.77 billion for the same period in 2011. Earnings per share of $1.13 in the quarter posted a 19% increase, versus $0.95 from the same period in the prior year. Gross margins for the first quarter of 2012 were at a record quarterly level of 58.8%, a 2% increase over the same period in the prior year. The improvement was as a result of cost reductions in manufacturing, restructuring programs, foreign exchange advantages and a constructive business mix.
The company’s sales and development initiatives in emerging markets produced increased costs in sales, general and administrative expenses for the first quarter of 2012. Research and development expenses increased 21% in the first quarter which accounted for 5% of net sales compared to 4.3% for the same period in the previous year. The CEO stated that the strong performance was led by its largest business segment, medical devices which posted double-digit advances in energy and vascular products. Medical device sales increased 6% in the quarter from the same period in 2011. Pharmaceutical sales were up 4% over the same period in 2011. Sales of medical supplies were flat in comparison to the first quarter of 2011.
On December 15, 2011, the company announced its plans to spin off its pharmaceutical business into a standalone public company which transaction is expected to complete in approximately 18 months.
In contrast to Medtronic, Covidien experienced strong sales of its vascular and energy medical devices in the first quarter of 2012. Emerging markets accounted for impressive sales growth led by stapling and energy products reflective of Covidien’s investment in accelerating growth in these markets. Sales, general and administrative costs decreased as a result of improvements of the timing of expenses and investments. The company expects that the first quarter of 2012 will deliver the most reductions in sales, general and administrative costs. The funding for Covidien’s emerging market investments will come from productivity initiatives, restructuring programs and cost reductions in manufacturing.
Covidien’s stated strategic initiatives are to broaden innovation focus; aggressively manage their existing portfolio of clients and products; investment in innovation; and, to capitalize on opportunities in emerging markets. Covidien also states that as one of the largest manufacturers and marketers in the healthcare industry it has the scale and diversity to invest in infrastructure and technology and to source low cost sources of supply and global distribution. It also states it has the ability to thrive in the healthcare industry as a result of its portfolio of leading brands, strong customer relationships and a cost effective operational structure.
Product liability issues are always present with medical device and equipment companies. Insurance costs in the industry are prohibitive to companies that do not have a large portfolio of devices and products to service a broad cross section of medical needs. Medtronic is fortunate in that it has been in existence for a long period of time, services many different geographic areas and has a large portfolio of diverse products. Still, the company has made it clear that there are difficulties with certain sectors of its business and that these difficulties will continue to hamper future growth until they are resolved.
When assessing these two companies, it appears that Covidien has taken up the slack in the vascular and energy markets where Medtronic has been experiencing a slowdown. Both companies service the same markets in terms of products, both companies are trying to increase their footprint in emerging markets. Both companies trade at relatively the same multiple to book value. Medtronic has substantially more debt than Covidien but has a higher dividend yield. Medtronic’s dividend yield is a function of the stock price, which is having some difficulty in relation to its relatively slow growth. Medtronic’s performance is not dismal, it just isn’t robust, which can be attributed to the macro economic factors affecting all companies in every industry.
Side by side, Covidien is the better company. It has a better cash to debt position, its revenue and earnings growth shows more promise and it has the added bonus of spinning out its pharmaceutical division to a standalone public company. A company that pays dividend in cash and spins off a division that the existing shareholders will participate in, is always a healthy choice for investors.
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