Medtronic Motors Ahead

Shares of medical equipment maker Medtronic (NYSE: MDT  ) soared yesterday and continue to buck the downtrend on Wall Street today, in the wake of a fiscal Q2 2008 earnings report that exceeded expectations for both sales and profits.

Granted, those expectations were set pretty low. All Medtronic had to do to clear Wall Street's hurdle was post 2% sales growth (helped considerably by a weak dollar, which inflated foreign currency earnings into 12% sales growth abroad) and a 2% decline in profits.

By segment:

  • Medtronic's diabetes treatment products (in particular, "pump therapies" and "continuous glucose monitoring products") and its ear, nose, and throat division were Medtronic's best performers, each growing sales 16% year over year.
  • Close seconds were spinal (including the Kyphon acquisition) and neuromodulation products; both these businesses grew sales 10%.
  • "CardioVascular" -- the business that competes with Boston Scientific (NYSE: BSX  ) and Johnson & Johnson (NYSE: JNJ  ) in the drug-coated stent market -- grew 8%.
  • And the quarter's twin laggards were Cardiac Rhythm Disease Management (CRDM), hurt by the previously announced Fidelis lead recall; and also Physio-Control (PC), which experienced a recall of its own and suffered a 33% decline in sales. If not for the Fidelis lead recall, CRDM revenues would have actually increased.

Now, for the good news
Medtronic doesn't give a huge amount of "color" to its quarters in the text portion of its press releases. Fortunately, it does include complete income statements, balance sheets, and cash flow statements. And if a picture's worth 1,000 words, a table chock-full of numbers must be worth a good 2,000 or so. Here's what Medtronic's numbers tell us:

Free cash flow generation for the first fiscal half increased 44% in comparison to fiscal H1 2007. So far this year, Medtronic has generated more than $1.5 billion in cash profits, or about 14% more than it reports as "profit" under GAAP. As good as that sounds, however, there's room for further improvement. With sales rising a bare 2%, it's good to see that Medtronic sold down its inventories by 5% in comparison with this time last year. But the firm's accounts receivable are tracking nearly 11% higher. If Medtronic can improve its bill collection while keeping tight rein on inventory growth, we could see further improvements in free cash flow in the future.

Personally, I'll need to see this improvement before I would consider investing in the firm. With a run-rate on free cash flow that suggests cash profits could reach $3 billion this year, the firm trades for 18 times its expected free cash flow. Nice, but if analysts are correct in predicting that Medtronic will grow its profits at about 14% per year long term, the shares don't look exceptionally cheap to me today. Call this one "fairly priced," at best, and leaning toward overvalued.

Take Medtronic's earnings pulse as you read:


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