Watching Medtronic (NYSE: MDT) over the past decade has been an interesting case study. Medtronic used to be one of the great growth stories of the med-tech world and the valuation reflected it, even well past the point where growth could no longer keep up. Since then, Wall Street has over-corrected and Medtronic now seems underestimated and underappreciated. True, Medtronic will never return to its go-go growth days and there is something of a lumbering titan about this company, but what titans may lack in dexterity, they can often make up in staying power.
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Fiscal Q2 - Little Expected and That's What Was Delivered
Medtronic's fiscal second quarter wasn't great, but nobody expected that it would be. Revenue rose 6% as reported, with constant currency growth of 3% and organic growth in the vicinity of 1%. That's not impressive; more like Johnson & Johnson (NYSE: JNJ), than Covidien (NYSE: COV) or St. Jude (NYSE: STJ).
Growth was led by cardiology, neurology and diabetes care, where growth ranged from 6 to 10%. The huge (more than one-quarter of sales) CRM business shrank by about 2%, while the spine business was down a similar 3%. On the profit side, though, Medtronic showed a bit more vigor. Gross margin improved ever so slightly and the company posted 9% growth in operating income. (To know more about income statement, read: Understanding The Income Statement.)
A Stronger Pulse in CRM
Medtronic's ICD business saw an 8% sales decline and it seems as though much of the momentum in that space, such as there is, is still with St. Jude, as Boston Scientific (NYSE: BSX) has yet to really recover. The pacemaker business is a different situation, though; sales here rose 4%, due in large part to the company's MRI-safe Revo product. This product is exclusive to Medtronic and is reaping double-digit price premiums; it's a big part of the re-acceleration in pacemaker sales. Better still, Medtronic is well ahead of its rivals in this technology and should have an MRI-compatible ICD on the market before too long.
Spine - Could Have Been Worse
Although Medtronic has avoided the generally slower-growth hip and knee orthopedics market, spine has slowed down, as well. Medtronic is far and away the big fish in this space; even with the acquisition of Synthes and a doubling of its share, JNJ will be about ten points behind Medtronic. Sales contraction of 3% doesn't look very encouraging, but the reality is that the company is navigating the problems with its Infuse product better than many analysts expected and is winning the legal fight against rival Nuvasive (Nasdaq: NUVA).
Can Growth Opportunities Move the Needle?
One of the biggest challenges for Medtronic is that so much of the company's revenue comes from slower-growing markets, like CRM, spine and drug-coated stents. Still, slow growth does not mean no growth and the possibility of share growth should not be underestimated. Medtronic could again be a share-taker, with an MRI-safe ICD and a new stent platform, they could take some business from Boston Scientific and Abbott Labs (NYSE: ABT).
There are also opportunities for greenfield growth. Although the company is behind Edwards Lifesciences (NYSE: EW) with its transcatheter valves, the clinical data has been encouraging and this will likely become a duopoly market, with St. Jude and Boston Scientific trailing even further behind.
Even more exciting is the company's opportunity in renal denervation. This experimental procedure holds the promise of offering significant benefits to patients with drug-resistant hypertension and Medtronic looks to be furthest along in the development time line. St. Jude, JNJ and Boston Scientific are also developing products for this market and safety is still a valid concern, but this could quickly become a multi-billion dollar market for Medtronic.
The Bottom Line
Wall Street is disenchanted enough with this stock that even just low single-digit revenue growth and no margin leverage, suggests it's underpriced by at least 30%. Admittedly, it will be a challenge for Medtronic to deliver strong growth again, with so much of its business in slower-growing indications, but those expectations look pretty manageable.
Investors who need more growth in a stock should check out Covidien or St. Jude. Value investors, though, should take a long hard look at Medtronic. It is not the company that it used to be, but then neither is the valuation and this could be a solid conservative play with some growth upside. (To know more about value investing, read: The Value Investors' Handbook.)
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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.