I've been relatively optimistic about St. Jude Medical's (NYSE:STJ) long-term prospects as the company navigates its current multi-year lull in growth. The company has a legitimate presence in important markets like cardiac rhythm management, atrial fibrillation, neurostimulation, and heart valve replacement, plus a pipeline that could reignite growth. With all of that said, it's still getting harder to ignore the realities of just how growth-challenged the company is in the here and now. Although I do believe the long-term expectations for St. Jude are increasingly beatable, this could be a frustrating stock to own for a little while yet.

SEE: A Checklist For Successful Medical Technology Investment

Broad, But Relatively Shallow, Shortfalls in Q1
St. Jude's first quarter was definitely a mixed bag. Relative to Wall Street expectations, the company posted only small misses on the top line and the operating income line, while below-the-line results actually led to a one-cent outperformance. On the other hand, almost every business category was soft.

Revenue was down about 3% on a constant currency basis this quarter. In the cardiac rhythm management business, sales fell 7% on an 11% decline in pacemaker sales and a 4% decline in ICDs. While it's still early, I'd suspect those results will be better than those of Boston Scientific (NYSE:BSX) and worse than Medtronic (NYSE:MDT), but I do believe St. Jude is losing pacemaker share.

Sales in cardiology were flat and neuromodulation was down 3%. Outside of the transcatheter heart valves sold by Medtronic and Edwards Lifesciences (NYSE:EW), these results are pretty consistent with both industry groups. Atrial fibrilation sales (ablation, mostly) were up only 7%, an unimpressive performance relative to the low-teens growth at Johnson & Johnson (NYSE:JNJ).

Where St. Jude did perform better was on the margin lines. Gross margin fell more than a point from the year-ago level, but came in about a half-point better than expected. Operating income was a similar, albeit somewhat weaker, story. Operating income declined 6%, but St. Jude's operating margin (which fell a half-point) was about 20bp better than the Street average (suggesting some loss of leverage through SG&A and R&D).

SEE: A Look At Corporate Profit Margins

It Could Get A Little Darker Before The Dawn
While St. Jude management seemed cautiously optimistic, management guidance always needs to be taken with a grain of salt. In the case of St. Jude especially, there are reasons to worry both about the overall health of the cardiac rhythm management business as well as the company's market share as the controversy over the company's Durata leads continues to play out.

Longer term, though, I think there are some reasons for optimism. New products like a line of value-priced pacemakers and the Nanostim leadless pacer could rebuild some momentum in CRM. I'm also more optimistic than many sell-side analysts about the firm's potential in transcatheter heart valves and renal denervation. Likewise, I think St. Jude is making solid moves in atrial fibrillation, where new catheter introductions and the MediGuide platform could help the company compete against large rivals like Medtronic and Johnson & Johnson, as well as smaller players like AtriCure (Nasdaq:ATRC).

That said, St. Jude has shown recently that it's unwise to count the pipeline eggs before they hatch. Data for the company's PFO and left atrial appendage products weren't great, and it's harder now to argue for blockbuster potential in those products. The same could prove true in heart valves and renal denervation, where there will be ample competition in these growing markets.

SEE: Equity Valuation In Good Times And Bad

The Bottom Line
I think it's generally a bad idea to make drastic whipsaw changes to estimates, but I have revised my expectations on St. Jude a little lower. I'm now looking for long-term revenue growth of about 3% and long-term free cash flow (FCF) growth of 4%. Those numbers could well prove conservative if the pipeline pans out, but by the same token the near-term growth outlook could worsen dramatically if there's a recall tied to Durata.

Those growth estimates lead to a fair value target near $43 for St. Jude today. That's still below today's price, and it's well worth noting that I think I'm erring on the side of conservatism with those growth projections. Still, even in the somewhat overheated world of med-tech, investors can find alternatives that are both cheaper on a long-term basis and stronger in the near term.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Fundamental Analysis

    How To Decode A Company's Earnings Reports

    Read between the lines to decipher a company's true financial condition.
  2. Insurance

    A Checklist For Successful Medical Technology Investment

    Find an investment that will give your portfolio a shot in the arm.
  3. Investing Basics

    DCF Valuation: The Stock Market Sanity Check

    Calculate whether the market is paying too much for a particular stock.
  4. Bonds & Fixed Income

    Equity Valuation In Good Times And Bad

    Learn how to filter out the noise of the market place in order to find a solid way of determing a company's value.
  5. Markets

    Using Accounting Analysis To Measure Earnings Quality

    Learn the accounting concepts that will help you to dig into to the details to find earnings manipulation.
  6. Markets

    Investment Valuation Ratios

    Learn about per share data, price/book value ratio, price/cash flow ratio, price/earnings ratio, price/sales ratio, dividend yield and the enterprise multiple.
  7. Investing Basics

    Learn How to Trade Semiconductor Stocks in 4 Steps

    The enormously diverse semiconductor industry requires market players looking for exposure have specialized knowledge.
  8. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  9. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  10. Investing News

    Why the Philippines Is the #1 Source for Tech Startups & Talent

    In the last few years, the Philippines has been working diligently to re-invent itself, and that work has paid off. The Southeast Asian nation is rapidly gaining notoriety as a leading source ...
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  5. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!