Medtronic - Life In The Crosshairs

By Stephen D. Simpson, CFA | May 28, 2010 AAA

When you execute as well as Medtronic (NYSE: MDT) has over the years, when you become a leading company in virtually every market in which you compete, you get the dubious reward of being the company everyone else wants to knock off the mountain. So far, though, Medtronic management continues to demonstrate that it is capable of taking a huge business and making it even bigger.

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The Quarter That Was
Medtronic reported its fiscal fourth quarter results May 25. As has been the case of late, the results were "good ... but not great". Revenue was up about 6% in constant currency terms, and that was more or less in line with expectation. Likewise, bottom-line earnings per share were up 9% and two pennies higher than the average analyst estimate.

Medtronic saw a decent quarter in cardiac rhythm management, as revenue rose 8% amidst the recall from Boston Scientific (NYSE: BSX). Looking at these results, it is possible that Saint Jude (NYSE: STJ) might have benefited even more from Boston Scientific's mistake.

Elsewhere, the company saw good growth in cardio, diabetes, surgery and defibrillation (where the company resolved FDA problems and can now compete more freely with ZOLL Medical (Nasdaq: ZOLL) and Philips). Results in the spine and neuro-modulation business were not quite so impressive, though.

Competitors Continue To Sharpen Their Knives
While patents, long development times, physician preferences and publicly published efficacy and safety data all help to stymie competition in the medical technology sector, the enormous financial rewards guarantee that competitors never give up on a good market. To that end, Medtronic may be starting to see some of its leadership erode.

In the lucrative spinal market, Nuvasive (Nasdaq: NUVA) has been an impressive grower for some time, and it now also looks as though CareFusion (NYSE: CFN) is making serious inroads into the $600 million kyphoplasty market that Medtronic had largely had to itself. Medtronic also faces a heart valve competitor with strong clinical data in Edwards Lifesciences (NYSE: EW) and its Sapien valve. And don't forget the "usual suspects" like Boston Scientific, Saint Jude and Abbott Labs that compete with Medtronic in overlapping markets.

A Different Company Than What Came Before
By no means am I sounding the death knell for Medtronic. This company spends inspiring sums of money every year on R&D, and it has been a willing (and smart) acquirer when management has realized that it cannot rely on its own internal efforts, or when it is simply cheaper to buy an existing business. Moreover, the management changes discussed on the company's conference call suggest that the company continues to look for ways to position the organization to be more responsive in the future.

The advantage for new potential investors today is that I think Medtronic has largely finished the transition from "growth company" to "mature, but growing, company" and all of the attendant volatility and valuation compression that goes with that process. Today, the company is still producing double-digit returns on capital and double-digit operating income growth, but the valuation on the stock is rather reasonable. (For more, see A Checklist For Successful Medical Technology Investment.)

Bottom Line
The days of Medtronic as the growth titan of med-tech are over. In its place is a company with excellent historical financial performance, double-digit growth prospects, leadership positions in a host of growing markets, a first class R&D operation and a management willing to share the spoils with shareholders in the form of dividends and share buybacks. So while investors absolutely should keep an eye on the competitors, they can take some solace in the fact that Medtronic has built up quite a lead, and it will take some time for even the most effective rivals to close in. (For more, see 3 Secrets Of Successful Companies.)

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