St. Jude Medical (NYSE:STJ) is one of the relatively few large-cap medical technology companies managing to deliver ongoing growth through this tough part of the cycle. Unfortunately for shareholders, there is a great deal of uncertainty about whether St. Jude is going to continue to deliver enough growth to make the stock appealing for the long-haul.
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The Quarter That Was
St. Jude reported total revenue growth of 7% for the third quarter, with the company's large CRM (cardiac rhythm management) business growing at 7%, and the smaller atrial fibrillation and neuromodulation businesses growing 8% and 11% respectively. Relative to "same-store" results from Boston Scientific (NYSE:BSX) and off-calendar comparisons to Medtronic (NYSE:MDT), St. Jude is almost certainly capturing shares in the large and lucrative (but slow-growing) CRM market. That is a good thing, as that is 60% of the company's business.
It seems as though every company has "one time" charges every quarter these days, so assessing St. Jude's profitability is subject to that disclaimer. Still, it appears that gross margin fell by about 150 basis points from last year, while operating income rose just under 10%. Those are not bad numbers per se, but the lower gross margin is a reason for pause. (For more, see Money To Be Made In Medical Devices.)
The Road Ahead
St. Jude has done well with past acquisitions (like Radi, Endocardial Solutions and Advanced Neuromodulation), and that should give investors some confidence that the recent deal for AGA Medical (Nasdaq:AGAM) will pay off in time. The question, though, is whether that will be enough. True, AGAM has four potential $1 billion product opportunities (which would almost double St. Jude's current revenue base), but the odds of going four-for-four are long (especially for AGAM's migraine application).
Longer term, the company needs to drive both revenue growth and higher cash flow efficiency. The company has benefited in the past from lower tax rates and so on, but those are not necessarily repeatable. That places an ongoing burden on the company to improve operating efficiency just to hold the line on its free cash flow conversion. (For related reading, check out 5 Stocks With Solid Cash Flow.)
The Bottom Line
St. Jude is unlikely to take a big swing and buy a company like Edwards Lifesciences (NYSE:EW), though a deal for a company like ZOLL (Nasdaq:ZOLL), Abiomed (Nasdaq: ABMD) or Thoratec (Nasdaq:THOR) could be viable. On its own, though, St. Jude will have its work cut out achieving the free cash flow growth it needs.
As it stands, St. Jude is probably slightly undervalued at today's price. Adding just 1% to the 10-year free cash flow growth rate would boost that target by about 6%, so that is the scale of the leverage that St. Jude faces. At today's prices, there are more interesting healthcare ideas, but St. Jude is at least holding its own in tough times. (For more, see Investing In The Healthcare Sector.)
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