This year has turned out to be an odd one for the medical technology industry. Although the overall performance of the sector has basically matched the year-to-date performance of the S&P 500 (a low teens gain for the year), it has very much been a "stock picker's market" with individual company stories standing out against a backdrop of only modest volume growth and ongoing pricing pressure.
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Ortho Good, Cardio Bad?
It would seem that investors have regained a fair bit of confidence in the long-term health of the orthopedic device industry. Companies like Wright Medical (Nasdaq:WMGI), NuVasive (Nasdaq:NUVA) and Zimmer (NYSE:ZMH) have all logged solid market-beating returns for the year. It's worth noting, though, that none of these companies have seen dramatic end-market improvements yet - growth in hip and knee reconstruction is still in the very low single-digits, and likewise the spinal care market has yet to rebound strongly.
On the other side of the ledger, investors remain skeptical towards companies with a sizable exposure to the cardiology market. In particular, the three major players in cardiac rhythm management (CRM), Medtronic (NYSE:MDT), St. Jude (NYSE:STJ) and Boston Scientific (NYSE:BSX), have all lagged the med-tech sector and the S&P 500. Some of this can certainly be tied to the sluggish volume and pricing trends in CRM, but it's worth noting that these companies do have other challenges as well.
Medtronic has struggled with a weak spinal care market and problems tied to its InFuse bone graft product. Boston Scientific continues to struggle to turn around a business that has been hammered by share loss and an uncertain strategic direction. St. Jude has been heavily talking up its robust pipeline, but worries about the company's CRM lead business have intensified, with some analysts openly speculating on the need for product recalls.
SEE: 5 Most Costly Product Recalls
Individual Stories Still Stand out
As mentioned in the introduction, this has been a year where many strong individual stories have stood out from their broader industry groups. General surgery hasn't been all that strong, but companies like Covidien (NYSE:COV) and Bard (NYSE:BCR) have done quite well nonetheless. Likewise, Baxter (NYSE:BAX) has been an uncommonly strong story this year - more as a result of investors coming back to the story than any particularly strong financial performance (nine-month sales were up 4% through the end of September).
Ongoing optimism about transcatheter heart valves and double-digit revenue growth has continued to propel Edwards Lifesciences (NYSE:EW) higher (up about 26% year to date), while concerns about procedure volumes have weighed on Intuitive Surgical (Nasdaq:ISRG).
SEE: A Checklist For Successful Medical Technology Investment
The Bottom Line
Looking out into 2013, there are definitely some meaningful challenges for the sector. The gradual improvement of the United States job market is a positive, but the imposition of the medical device excise tax is going to pressure company margins, particularly so for the smaller companies. At the same time, there are significant pricing and reimbursement pressures in the U.S. and Europe that are limiting revenue growth opportunities.
On the positive side, it would seem that the industry is past the worst of the readjustments in orthopedics and CRM, and ongoing clinical progress in areas like transcatheter valves and renal denervation could provide a tailwind for companies like Medtronic, St. Jude, Boston Scientific and Covidien.
All in all, then, it looks as though 2013 will be a relatively typical year for the sector. While there will be some definite external challenges, companies with strong new products will likely rise above those challenges and deliver solid revenue and profit performance.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.