Barron’s: Medtronic Looks Cheap

Barron’s likes Buy List favorite Medtronic ($MDT):

In the 1990s, cutting-edge technology helped make Medtronic one of the market’s fastest growing big-cap medical-device makers.

But that was then. In recent years, Medtronic (ticker: MDT) has morphed into a slow-growing behemoth that has been hobbled by sluggish markets and safety concerns about some of its products.

The stock is currently trading 24% below where it sat five years ago.

But signs of a turnaround are evident as U.S. markets for implantable defibrillators and spinal devices are beginning to stabilize. Meanwhile, Medtronic’s effort to expand sales in emerging markets and launch new products can help it exceed tepid growth expectations.

The stock has gained 25% in the past year yet continues to trade at a cheap valuation. At roughly 11 times forward earnings, Medtronic could deliver 20% returns over the next year if Chief Executive Omar Ishrak can deliver on his promises regarding sales growth.

Add a 2.5% dividend yield, and “Medtronic is a cheap stock with an attractive dividend embarking on measures that can help move the stock price,” says BMO Capital Markets analyst Joanne Wuensch.

Founded in 1949, Medtronic makes devices that treat heart failure, fix damaged spines and monitor diabetes.

Revenue totaled $16 billion during the fiscal year that ended in April 2012, led by its cardiac-rhythm-management unit, which specializes in pacemakers and implantable defibrillators and generated roughly one-third of total sales.

But it’s been a tough time for Medtronic and the medical-device industry. Product prices are falling. A weak economy has hurt hospital admissions. Insurers are pushing back on expensive procedures.

And thanks to competition and government scrutiny of the stent and ICD markets, Medtronic’s former growth engine has run out of gas.

But chief financial officer Gary Ellis told investors Tuesday that Medtronic has reached an inflection point. Sales growth has begun to accelerate. And Ellis told investors at a Morgan Stanley conference that the headwinds facing its top markets “seem to be blowing away,” and allowing growth in other parts of the company to shine through.

Granted, Medtronic executives are playing things cautiously until they see signs that the device market will remain stable.

Last month, the company backed its previous guidance for the current fiscal year, which runs through April 2013, even though it had just reported sales growth for its latest quarter that exceeded its full-year target.

“Even though we were encouraged by [first-quarter results], we recognize that we need to deliver this kind of performance consistently over the long term,” Ishrak told investors during a conference call that same day.

Medtronic sees revenue growing between 2% and 4% this year and expects to earn between $3.62 a share and $3.70 a share, which suggests a 5% to 7% profit increase.

Right now, Medtronic’s biggest advantages remain its scale and the breadth of its portfolio, says T. Rowe Price analyst Mark Bussard.

The company also generates roughly $4 billion in free cash flow annually. And Ishrak plans to return half of it to shareholders through dividends and share repurchases.

Medtronic remains focused on improving profit margins with a goal to cut product costs by $1.2 billion in the next five years. And by then, emerging markets should make up 20% of sales, up from 10% today and new products will hit the market.

A new drug-coated stent called Resolute Integrity received approval from the Food and Drug Administration in February. U.S. sales should reach $384 million for the device, which has already captured 25% market share here and in Europe, according to some estimates.

A new heart valve that can be implanted without open-heart surgery should hit the U.S. market in 2014. And the following year could see the arrival of a novel treatment for uncontrolled hypertension called renal denervation.

By 2015, the Street sees Medtronic’s revenue exceeding $17.4 billion.

Of course, turnaround stories are risky. Investors want proof that Medtronic has turned a corner. So a dip in sales or any further volatility in big device markets will be severely punished by investors.

And a big ship like Medtronic doesn’t turn on a dime.

But for patient investors, Medtronic can deliver potent returns.

Posted by on September 12th, 2012 at 12:44 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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