Covidien (NYSE:COV) has been one of the strongest large-cap med-tech stories over the past year or so. At a time when companies like Johnson & Johnson (NYSE:JNJ), Stryker (NYSE:SYK), Medtronic (NYSE:MDT), and Bard (NYSE:BCR) have been struggling to report much of any organic growth, Covidien has been solidly in the mid-single digits as the company reaps the benefit of past investments in R&D and product development.
Nothing lasts forever, though, and it looks like Covidien is lapping some challenging comparables. What's more, the overall healthcare market remains pretty sluggish and many of Covidien's rivals have stepped up their game with new product introductions. The spin-off of Mallinckrodt could unlock some value, but it looks like the market is pretty well up to speed with Covidien's value.
Fiscal Second Quarter Results Okay, But Devices Soften Up
Covidien reported organic growth a bit above 5% this quarter, with “operational growth” of about 6% in devices. That continues to make Covidien one of the strongest growers in the large med-tech space, so talk of disappointing or slowing growth has to be kept in context. Covidien's large endomechanical segment saw 6% constant currency growth, while soft tissue was fairly weak. Oximetry was the growth leader (up 15%), while vascular and energy both delivered solid (6% to 8%) growth.
While device growth disappointed aggressive Street expectations, Covidien's drug business was surprisingly strong at 13% growth. The company's specialty (up 53%) and API (up 12%) businesses were both very solid, while the contrast business (down 11%) and radiopharmacueticals (down 6%) were both weak.
Margin performance at Covidien was basically okay. Gross margin did decline, down about half a point, and slightly missed the average estimate. Operating income up was more than 5% and Covidien came in about half a point higher than expected on margin.
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Losing A Little Share, But Not Losing The War
Based on reported results for this calendar quarter, it does look like Covidien has lost some share in peripheral to Johnson & Johnson and in artherectomy to Cardiovascular Systems (Nasdaq:CSII), though it's well worth noting that share in artherectomy moves back and forth pretty frequently. Covidien also looked a little soft in soft tissue relative to Bard.
Given that Covidien has seemingly had everything going their way for the past year (or more), I can't get too worked up about these numbers. J&J and Bard are too strong to stay down forever, and there's a big difference between losing some share and going into freefall. Likewise, the company's core surgery businesses (endomechanical and energy) is still pretty strong.
Certainly Intuitive Surgical (Nasdaq:ISRG) is a threat in some very particular procedures, but companies like Olympus and Conmed (Nasdaq:CNMD) are going to have their work cut out grabbing meaningful share from JNJ and Covidien in areas like energy. Likewise, even with Stryker's solid performance in neurovascular, it seems pretty clear that Covidien is still doing very well in this market segment.
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Spin Details Coming Soon
By the end of this week (May 3), investors should have more information on the company's upcoming spin-off of Mallinckrodt. Although this move has its positives and negatives for Covidien (it will likely improve Covidien's margins but hurt the the effective tax rate), it very well could unlock some value for investors. Unlike Abbott (NYSE:ABT), Covidien's drug business never really got a lot of attention I think the business's strong position in pharmaceutical ingredients, generics, and nuclear medicine has been overlooked to some extent.
The Bottom Line
With Covidien's med-tech momentum slowing a bit and the company talking about the need to invest in building up its emerging markets business, I've trimmed down my growth expectations a bit. At the same time, the Street had embraced Covidien as one of the few med-tech growth stories and bid up the shares. Consequently, I'm not quite as positive on Covidien as I have been in the past.
I still expect Covidien to deliver good growth relative to its peers (long-term free cash flow (FCF) growth in the high/mid single-digits) and I believe this is a quality med-tech franchise. I just happen to think that the mid-$60s is about as high as the stock should go right now, so the near-term potential is not that exceptional even if the long-term returns should still be quite solid.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.