Medtronic (MDT, Financial) is one of the world's largest medical device companies. The company develops and manufactures therapeutic medical devices for chronic diseases such as pacemakers, defibrillators, heart valves, stents, insulin pumps, spinal fixation devices, neurovascular products, advanced energy and surgical tools.
Medtronic operates under four distinct segments: Cardiovascular, Medical Surgical, Neuroscience and Diabetes. The largest of these is the Cardiovascular segment, which represents roughly 35% of total company revenues.
The company markets its products to health care institutions and physicians in the United States and overseas. International sales account for almost 50% of the company's total sales. Medtronic is based in Ireland and currently has a $128 billion market cap.
Medtronic has had a tough few years. Back in December 2021, they received a warning letter from the FDA related to one of the company’s diabetes device manufacturing operations. This may affect their ability to make and distribute insulin pumps, which is one of their key products. The warning letter was issued following an inspection during 2021 related to recalls of the MiniMed 600 series insulin infusion pump and a remote controller device for MiniMed 508 and Paradigm pumps. The FDA focused on the insufficiency of device quality system requirements at its California facility in the areas of risk assessment, corrective and preventive action, complaint handling, device recalls and reporting of adverse events.
The company plans to correct these problems using both internal and external resources such as consultants. However, it faces even more issues in the form of supply chain issues related to China's Covid shutdowns. These short-term factors should eventually be resolved, but for now, they have offered a potential value opportunity to investors in the form of lower share prices.
Financial review
Medtronic recently released the fourth quarter and full-year results for its fiscal year ended April 2022. Revenue growth was decent at 5.0% for the year, but the quarter saw revenues decline 1.0%, causing the company to miss consensus estimates.
On a global basis for the quarter, revenues were $8.1 billion, which on an organic basis was an increase of 1.0%. However, the results were negatively affected by temporary issues related to global supply chain issues, particularly in Surgical Innovations, thanks to Covid-related shutdowns in Chinese factories. U.S. revenues, which represent about half of total company revenues, decreased 2.0%. Development markets revenues increased 4.0% and emerging market revenues increased 7.0%.
For the full fiscal year, non-GAAP diluted earnings per share increased 26% and cash flow from operations was up 18%. Free cash flow was strong at $6.0 billion.
As of the end of the quarter, the company had $10.6 billion in cash and investments on the balance sheet with total debt of about $24.1 billion. Medtronic typically generates substantial free cash flow, which has been in the $5 billion to $6 billion range over each of the last several years. The company targets a free cash flow conversion rate of at least 80% of operating cash flow.
Valuation
On June 8, the company issued 2023 guidance in conjunction with its earnings release, which calls for organic revenue growth in the range of 4% to 5%. Adjusted earnings per share is expected in the range of $5.53 to $5.65, with analysts's consensus estimates coming in the middle of that range at $5.57.
That puts the company trading at 17 times this fiscal year's earnings and 16 times estimates for the next fiscal year. Medtronic sells at an enterprise-value-to-Ebitda ratio of approximately 13 times.
The GuruFocus discounted cash flow (DCF) calculator gives a fair value estimate of approximately $106.00 using the following assumptions: $5.57 as the starting point for earnings per share, an 8.0% long-term growth rate and a 9% discount rate.
The company has increased its dividend annually for the last 45 years. The current annual dividend is $2.72, which translates to a yield of approximately 2.85%
Conclusion
Medtronic is a well-managed and high-quality medical technology company that appears to be slightly undervalued at this time, in my view. The company has stated in the past its long-term goal is to produce double-digit shareholder returns. This includes mid-single digit revenues growth, operating margin improvements, increasing the dividend roughly 10% annually and converting high levels of operating cash flow to free cash flow, which will support debt reductions and share repurchases.
