Companies, like people, do not often grow old gracefully. More often than not, parts stop working right, it takes more effort to achieve the same ends, and the overall pace slows down. While some accept this and do the best they can, others resort to cosmetic fixes to patch over the ravages of age. To that end, Medtronic (NYSE:MDT) seems to be handling its maturity with integrity and realism.
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A Mediocre Quarter
Medtronic's fiscal third quarter results are not likely to excite long-term investors that much. Revenue grew less than 3%, which was mostly in line with analyst expectations and overall medical device sector growth. That, then, is part of the problem with Medtronic - it has matured to a point where it no longer flies ahead of the pack. Looking at some of the details, the company's core CRM business saw revenue decline 2%, while spine grew by 2% and cardio rose better than 7%. Diabetes and surgical technologies were also solid growers (up 10% and 8%, respectively), but they are relatively small businesses for Medtronic. (For more, see Keeping Pace At Medtronic.)
Third quarter earnings quality looks a bit problematic. Although the company did beat the consensus estimate for the quarter, gross margin fell more than a full point, and operating income dropped more than 3% (with operating margin contracted two points). Like so many other companies, an unexpectedly low tax rate allowed the company to meet the earnings bogey, but the quality of that beat is low. (For more, see Strategies Of Quarterly Earnings Season.)
The Road Ahead
Continuing the theme of Medtronic's midlife crisis, the company is now facing a lot of "mature company issues." Investors are waiting to see what the company will do with its CEO transition and what the new leadership will have in mind to improve growth. That's a fair bit of uncertainty given the numerous possible pathways in health care. Will Medtronic sacrifice margins and boost R&D spending? Will Medtronic try to buy its way back into growth? Will management reposition Medtronic as more of a cash-farmer of stable businesses?
Beyond this, there are other signs of age as well. Some investors are pushing management to split the business and separate the higher and lower growth units. Along the way, management has also decided that the company is over-staffed and will be cutting a large number of jobs. That's just not something that growth companies do, so perhaps it is an acknowledgment of reality on the part of Medtronic.
In the meantime, growth prospects are looking quite a bit brighter at places like Edwards Lifesciences (NYSE:EW), Intuitive Surgical (Nasdaq:ISRG), and the more direct Medtronic rival St. Jude Medical (NYSE:STJ). What's more, Boston Scientific (NYSE:BSX) seems serious about getting its house in order and that could be a threat to Medtronic down the line. (For related reading, see Med-Tech Choice Is Simply Intuitive)
The Bottom Line
Medtronic's stock has done pretty well over the past three months and no longer looks like a great value play in the space. Abbott (NYSE:ABT) and Roche (Nasdaq:RHHBY) have similar growth worries weighing on their stocks, but look cheaper. Beyond that are turnaround plays like Boston Scientific or Nuvasive (Nasdaq:NUVA) as well as risky small-cap growth stories.
Medtronic does do an exemplary job, though, of translating revenue into free cash flow and that should not be underestimated. Medtronic also appears increasingly willing to share its cash with shareholders. All in all, then, it looks like Medtronic is navigating a difficult transition with a decent amount of skill. The downside of such a transition is that the company becomes a somewhat staid and dull dividend-payer, and as far as downsides go, that really is not too bad at all. (For more, see A Checklist For Successful Medical Technology Investment.)
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