Medtronic Inc. (MDT, Financial), based in Minneapolis, started in the founders' home garage in 1949 and is now the world's largest specialized medical devices company. (Note that JNJ´s medical devices/diagnostic unit had a 2010 turnover of 24.6B compared to Medtronic´s $15.8B) The company is involved in the following key areas: cardiac rhythm disease management or CRDM (pace-makers etc), spinal disorders, cardiovascular disease (stents etc), neuromodulation, diabetes (insulin pumps), surgical technologies and physio-control. The company has a market cap of around $42B and currently receives over 40% of revenues from outside the US.
There are two powerful and obvious drivers to the company's future growth; the first being the ageing of populations in developed economies with large increases in healthcare inevitable over the next 20 years. The second key driver is the rising affluence in emerging economies, especially China and other BRIC countries, which if current growth continues, will provide a continually growing demand for healthcare, including medical devices.
Although medical devices companies face patent expiry problems, as do pharmaceutical companies, this is not such a serious problem as in the pharmaceutical industry. For example, a device like a heart pacemaker may contain a number of different patents for different components, which means that the expiry of just one of these patents will not enable competitors to duplicate the whole device. In addition there are quality issues to be considered. If a medical device company has built a reputation as a reliable and quality supplier of a particular life-saving device, will a medical practitioner be prepared to take the risk of using a cheaper version made by another, as yet unproven company?
Competition
Medical devices is a highly competitive industry, which means that success depends upon continual investment in R&D to develop ever-better medical technologies, as well as excellence in operations, management and marketing. As can be expected, Medtronic has a strong on-going R&D program.
Medtronic´s largest segment is CRDM (pace-makers etc), where it is currently the market leader with around 50% market share. Direct competitors in this segment are Boston Scientific and St Jude Medical.
Other main competitors of Medtronic include Johnson & Johnson (JNJ), Zimmer (ZMH) and Stryker (SYK).
Earnings record
The adjusted eps figures given above are those supplied by Medtronic Inc, and exclude non-recurring items such as restructuring costs and legal costs. However when you look at the record of these costs, large legal expenses occur every year or two, mainly due to patent litigation; so it is questionable as to whether these really should be considered as non-recurring items.
The figure for 2011 is from company guidance.
The figures for growth are based on adjusted earnings since I believe this gives a more accurate picture of company performance.
As can be seen from the above figures, eps has almost doubled from 2004 to 2010, but during this time the share price has actually declined from about $50 to $40 now. In fact shareholders in Medtronic have had a very disappointing time since 2000, with the stock virtually at the same price as it was at the beginning of 2000, and with an historical maximum of around $60 achieved at the end of that year.
The company has been increasing dividends since 2004, with the payout ratio increasing from 18% in 2004 to 29% in 2010.
The return on equity for 2010 was 21%
Headwinds
For the first quarter of fiscal 2011 ending July 2010, the company reported a decrease in worldwide revenue of 4% or an increase of only 2% after adjusting for currency exchange rates and an extra week in first quarter 2009. In the important CRDM segment they reported a decrease in sales of 5% or an increase of 1% when allowing for foreign exchange and the extra week. The company cited weakness in the US and international healthcare markets as well as pricing pressure as reasons for the weak performance.
In the latest earnings release for Q3, 2011 the company reported an increase in worldwide revenue of 3%, with international sales increasing 7% on a constant currency basis. Earnings per share increased by 12% on an adjusted basis and 15% as reported.
Financial Strength
The company has a net debt to equity ratio of around 55% and interest coverage ratio of 17 (net interest). While having more debt than some of its competitors the company is still in a strong financial situation considering cash flow generated and the defensive, non-cyclical nature of the company's products.
Risks
One of the greatest risks for any medical devices company is the risk of litigation (or penalties) due to badly designed or insufficiently tested products which could result in patient death or injury. I consider this to be by far the greatest risk, but it not possible to put a figure on either the probability or possible extent of such risks. As can be expected, product safety is stated as the highest of all priorities at Medtronic. However this is an important consideration which may influence an investor's decision regarding portfolio weighting.
Another obvious risk is exchange rate variations (since the company receives over 40% of revenues from outside the US) although the company attempts to mitigate this risk by hedging activities.
In the 10K, 2010 the company also outlines other risk factors as including:
- competition and increasing pricing pressure
- increased Government regulation and scrutiny of the medical devices sector.
- patent infringement
- healthcare providers' cost-containment measures
Management
Medtronic has the kind of professional management you would expect from a company of this size and stature. In 2010 it was ranked 57 on Forbes annual list of America´s Most Reputable Companies.
The Chairman and CEO of Medtronic joined the company in 2002, following executive positions in companies including Johnson & Johnson, Eli Lilly and Guidant Corp. He has a BSc from Duke and MBA from Darden.
Over the years, management of Medtronic has pursued mainly organic growth combined with small bolt-on acquisitions, together with the acquisition of patents. The company is strongly focussed on technological innovation and the building of synergies and cross-linking between different product categories.
The company lists four key strategic initiatives:
- drive sustainable long-term growth through innovation
- maintain strong focus on improving operating margins
- deliver earnings per share growth and disciplined capital allocation
- align the organization for consistent and market-leading execution
In addition, management has recently prioritised its strategy for international expansion by redefining the business in terms of developed and emerging markets, rather than US and International markets.
In response to the relative weakness in current sales and earnings, management has responded appropriately by an aggressive cost-cutting and restructuring program involving a workforce reduction of 4 to 5%, as mentioned below under catalyst.
Valuation
The company is currently trading at a PE of 12 times adjusted 2010 earnings and 14 times reported 2010 earnings. The forward PE for 2011 is 11.5 With an average annual growth rate of 12% since 2004, the company has a PEG ratio of around 1, which is generally appreciated as an attractive valuation. It is a matter of conjecture as to what would be an appropriate PE to apply for fair value, but I would suggest between 15 and 16.5, which would result in a fair value price range of $51 to $56 compared to the current price of around $40. However I make no claim as to whether or when the share price may reach this higher level.
Catalyst
One catalyst to future performance of the company is the current restructuring program which involves a 4 to 5% reduction in the company's workforce. While this will result in a restructuring charge in the fourth quarter of 2011, the company should benefit from on-going cost-savings and increased efficiency.
Guru activity
While this may not be a conventional heading in a company analysis, I think it is appropriate at this site.
In the last quarter ending 31 December 2010 the following gurus either bought or added to their positions in Medtronic:
John Paulson
John Hussman
Andreas Halvorsen
David Tepper
Richard Snow
Joel Greenblatt
George Soros
Mario Gabelli reduced his holding by 30%.
It certainly helps me to sleep at night knowing that such an impressive list of gurus have recently bought this stock. The share price of MDT has moved up by around 11% since last quarter, but of course the S&P has also moved up by a similar amount.
Conclusion
The medical devices industry is difficult to analyse due to the complexity of the technologies involved. It is also subject to strong competition and there are uncertainties regarding future regulation and cost-saving measures by healthcare providers.
On the other hand the market served is undoubtedly due to grow significantly due to the ageing of populations in developed countries and the rising middle class in emerging economies.
Medtronic has reported earnings which tend to vary considerably due to the impact of litigation costs and restructuring charges, and one must assume that this is unlikely to change. However the company has still managed to grow earnings at 12% per year since 2004 and clearly appears to be currently selling at an attractive price with a considerable margin of safety.
There are two powerful and obvious drivers to the company's future growth; the first being the ageing of populations in developed economies with large increases in healthcare inevitable over the next 20 years. The second key driver is the rising affluence in emerging economies, especially China and other BRIC countries, which if current growth continues, will provide a continually growing demand for healthcare, including medical devices.
Although medical devices companies face patent expiry problems, as do pharmaceutical companies, this is not such a serious problem as in the pharmaceutical industry. For example, a device like a heart pacemaker may contain a number of different patents for different components, which means that the expiry of just one of these patents will not enable competitors to duplicate the whole device. In addition there are quality issues to be considered. If a medical device company has built a reputation as a reliable and quality supplier of a particular life-saving device, will a medical practitioner be prepared to take the risk of using a cheaper version made by another, as yet unproven company?
Competition
Medical devices is a highly competitive industry, which means that success depends upon continual investment in R&D to develop ever-better medical technologies, as well as excellence in operations, management and marketing. As can be expected, Medtronic has a strong on-going R&D program.
Medtronic´s largest segment is CRDM (pace-makers etc), where it is currently the market leader with around 50% market share. Direct competitors in this segment are Boston Scientific and St Jude Medical.
Other main competitors of Medtronic include Johnson & Johnson (JNJ), Zimmer (ZMH) and Stryker (SYK).
Earnings record
| 2011 | 2010 | 2009 | 2008 | 2007 | 2006 | 2005 | 2004 | |
| Reported eps | 3.4 | 2.79 | 1.93 | 1.95 | 2.41 | 2.09 | 1.48 | 1.6 |
| Adjusted eps | 3.22 | 2.92 | 2.6 | 2.41 | 2.2 | 1.86 | 1.63 | |
| Growth % | 10.30% | 12.30% | 7.90% | 9.50% | 18.35% | 14% | ||
| Dividends | 0.9 | 0.82 | 0.75 | 0.5 | 0.44 | 0.39 | 0.34 | 0.29 |
The adjusted eps figures given above are those supplied by Medtronic Inc, and exclude non-recurring items such as restructuring costs and legal costs. However when you look at the record of these costs, large legal expenses occur every year or two, mainly due to patent litigation; so it is questionable as to whether these really should be considered as non-recurring items.
The figure for 2011 is from company guidance.
The figures for growth are based on adjusted earnings since I believe this gives a more accurate picture of company performance.
As can be seen from the above figures, eps has almost doubled from 2004 to 2010, but during this time the share price has actually declined from about $50 to $40 now. In fact shareholders in Medtronic have had a very disappointing time since 2000, with the stock virtually at the same price as it was at the beginning of 2000, and with an historical maximum of around $60 achieved at the end of that year.
The company has been increasing dividends since 2004, with the payout ratio increasing from 18% in 2004 to 29% in 2010.
The return on equity for 2010 was 21%
Headwinds
For the first quarter of fiscal 2011 ending July 2010, the company reported a decrease in worldwide revenue of 4% or an increase of only 2% after adjusting for currency exchange rates and an extra week in first quarter 2009. In the important CRDM segment they reported a decrease in sales of 5% or an increase of 1% when allowing for foreign exchange and the extra week. The company cited weakness in the US and international healthcare markets as well as pricing pressure as reasons for the weak performance.
In the latest earnings release for Q3, 2011 the company reported an increase in worldwide revenue of 3%, with international sales increasing 7% on a constant currency basis. Earnings per share increased by 12% on an adjusted basis and 15% as reported.
Financial Strength
The company has a net debt to equity ratio of around 55% and interest coverage ratio of 17 (net interest). While having more debt than some of its competitors the company is still in a strong financial situation considering cash flow generated and the defensive, non-cyclical nature of the company's products.
Risks
One of the greatest risks for any medical devices company is the risk of litigation (or penalties) due to badly designed or insufficiently tested products which could result in patient death or injury. I consider this to be by far the greatest risk, but it not possible to put a figure on either the probability or possible extent of such risks. As can be expected, product safety is stated as the highest of all priorities at Medtronic. However this is an important consideration which may influence an investor's decision regarding portfolio weighting.
Another obvious risk is exchange rate variations (since the company receives over 40% of revenues from outside the US) although the company attempts to mitigate this risk by hedging activities.
In the 10K, 2010 the company also outlines other risk factors as including:
- competition and increasing pricing pressure
- increased Government regulation and scrutiny of the medical devices sector.
- patent infringement
- healthcare providers' cost-containment measures
Management
Medtronic has the kind of professional management you would expect from a company of this size and stature. In 2010 it was ranked 57 on Forbes annual list of America´s Most Reputable Companies.
The Chairman and CEO of Medtronic joined the company in 2002, following executive positions in companies including Johnson & Johnson, Eli Lilly and Guidant Corp. He has a BSc from Duke and MBA from Darden.
Over the years, management of Medtronic has pursued mainly organic growth combined with small bolt-on acquisitions, together with the acquisition of patents. The company is strongly focussed on technological innovation and the building of synergies and cross-linking between different product categories.
The company lists four key strategic initiatives:
- drive sustainable long-term growth through innovation
- maintain strong focus on improving operating margins
- deliver earnings per share growth and disciplined capital allocation
- align the organization for consistent and market-leading execution
In addition, management has recently prioritised its strategy for international expansion by redefining the business in terms of developed and emerging markets, rather than US and International markets.
In response to the relative weakness in current sales and earnings, management has responded appropriately by an aggressive cost-cutting and restructuring program involving a workforce reduction of 4 to 5%, as mentioned below under catalyst.
Valuation
The company is currently trading at a PE of 12 times adjusted 2010 earnings and 14 times reported 2010 earnings. The forward PE for 2011 is 11.5 With an average annual growth rate of 12% since 2004, the company has a PEG ratio of around 1, which is generally appreciated as an attractive valuation. It is a matter of conjecture as to what would be an appropriate PE to apply for fair value, but I would suggest between 15 and 16.5, which would result in a fair value price range of $51 to $56 compared to the current price of around $40. However I make no claim as to whether or when the share price may reach this higher level.
Catalyst
One catalyst to future performance of the company is the current restructuring program which involves a 4 to 5% reduction in the company's workforce. While this will result in a restructuring charge in the fourth quarter of 2011, the company should benefit from on-going cost-savings and increased efficiency.
Guru activity
While this may not be a conventional heading in a company analysis, I think it is appropriate at this site.
In the last quarter ending 31 December 2010 the following gurus either bought or added to their positions in Medtronic:
John Paulson
John Hussman
Andreas Halvorsen
David Tepper
Richard Snow
Joel Greenblatt
George Soros
Mario Gabelli reduced his holding by 30%.
It certainly helps me to sleep at night knowing that such an impressive list of gurus have recently bought this stock. The share price of MDT has moved up by around 11% since last quarter, but of course the S&P has also moved up by a similar amount.
Conclusion
The medical devices industry is difficult to analyse due to the complexity of the technologies involved. It is also subject to strong competition and there are uncertainties regarding future regulation and cost-saving measures by healthcare providers.
On the other hand the market served is undoubtedly due to grow significantly due to the ageing of populations in developed countries and the rising middle class in emerging economies.
Medtronic has reported earnings which tend to vary considerably due to the impact of litigation costs and restructuring charges, and one must assume that this is unlikely to change. However the company has still managed to grow earnings at 12% per year since 2004 and clearly appears to be currently selling at an attractive price with a considerable margin of safety.
