Tuesday's ETF to Watch: Medical Devices ETF (IHI)

As equity markets continue to tread water, many investors who haven't fled for safe havens such as Treasuries and gold have turned to more defensive sectors of the U.S. equity market. Despite this flight to quality, ETFs in the Health and Biotechnology ETFdb Category have slumped so far in 2010, with most falling by more than 5% on the year. This slide is the result of numerous factors, as investors have feared the impact of the new health care bill will have on the industry, the lack of a solid drug pipeline for a number of firms, and decreased hospital spending as cost cutting takes center stage.  

This final issue has greatly impacted medical device makers that rely on hospital spending in order to generate sales of a product lineup that include MRI scanners, prosthetics, pacemakers, X-ray machines and other non-disposable medical devices. Due to the nature of these devices, device makers many tend to be highly cyclical -- demand tends to wane as an economic recession intensifies and hospitals decide to hold off on new purchases until the budget situation improves. With hospitals content to get by on outdated equipment, the medical device sector has struggled [see Will ObamaCare Put Health Care ETFs On Life Support?].

Medtronic (NYSE: MDT  ) , a Fortune 500 firm, is currently the world's largest medical device manufacturer. The company has seen its share price tumble thus far in 2010; it is now approaching its 52-week low of $34.35 after hitting a level close to $47 earlier this year. Analysts have cited a summer slowdown in medical procedures as well as weakness out of the company's Kyphon unit, which was purchased in 2008 for $4 billion, as the major reasons for the company's sharp decline.

When Medtronic reports earnings today, results from the spinal surgery segment will especially be under the microscope as tighter hospital budgets and increasing physician skepticism about the benefits of spinal surgery could limit demand for the company's second-biggest unit (it accounted for more than $3.5 billion in sales last year). Nevertheless, the company looks to report modest gains for this important unit and is expected to post earnings of $0.82 per share on sales of $4 billion, compared to last year's EPS of $0.76 on sales of $3.9 billion. Should Medtronic fail to live up to these expectations, look for the entire medical device industry to suffer as a result during this week's trading [also see Beyond XLV: Five Alternative Health Care ETFs].

With this key earnings report on tap, the iShares Dow Jones U.S. Medical Devices Index Fund (NYSE: IHI  ) figures to be active in Tuesday trading. IHI tracks the Dow Jones U.S. Select Medical Equipment Index, a benchmark that measures the performance of the medical equipment sector of the U.S. equity market and currently consists of about 40 stocks. In addition to its heavy weighting to MDT, the fund also offers large allocations to Thermo Fisher Scientific (8.1%), Stryker Corp (7%), and Intuitive Surgical (5.9%).

In terms of market capitalization levels, the fund is relatively well spread out, with roughly 50% going to large and giant caps, 33% to mid caps and the rest to small and micro-sized companies. The fund, like many in the health industry, has been hard hit by the recession, losing 8% over the past three months and sinking by close to 5.1% over just the past two weeks. However, a strong report and quality guidance out of top component Medtronic is likely to boost the spirits of IHI and could help to start a fall quarter turnaround for the struggling sector [see holdings of IHI here].

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Disclosure: No positions at time of writing; photo is courtesy of Bobak Ha’Eri.

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