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.

SEE: How To Decode A Company’s Earnings Reports

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.

SEE: Great Expectations: Forecasting Sales Growth

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.

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. Markets

    How To Choose The Best Stock Valuation Method

    Don't be overwhelmed by the many valuation techniques out there - knowing a few characteristics about a company will help you pick the best one.
  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

    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.
  6. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  7. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  8. Investing

    What Investors Need to Know About Returns in 2016

    Last year wasn’t a great one for investors seeking solid returns, so here are three things we believe all investors need to know about returns in 2016.
  9. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  10. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  1. 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 >>
  2. 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 >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center