Multiple Setbacks May Spell Opportunity at Medtronic, Inc.

Clinical disappoints and more aggressive rivals have pushed this large med-tech into value territory.

Feb 20, 2014 at 2:30PM

In a pretty richly valued med-tech space, it takes some setbacks to uncover value and opportunity. Medtronic (NYSE:MDT) has certainly seen setbacks, as the company has abandoned renal denervation, has lost some momentum in CRM, and may not be as competitive as hoped in drug-coated balloons. On a more positive note, transcatheter heart valves look like a viable growth driver and Medtronic has several opportunities in areas like neuromodulation, diabetes, and atrial fibrillation.

Some weak spots in the third quarter
It's often dangerous to read too much into any single quarter, and it is not as though Medtronic's was that bad. Revenue rose about 4% on an organic basis, which was good for a very slight beat versus the Street. Surprisingly, the company missed in cardiac rhythm management (CRM), as sales were up only 2% and that was largely due to an acquisition that boosted the AF results. Cardiology was up about 2% and spine was flat, while neuromodulation was up 7%, surgical tech rose 11%, and diabetes sales rose 16%. 

Margins were OK. Gross margin fell about half a percentage point from last year, but that was more or less as expected. Operating income rose about 4% and missed expectations by a basically trivial amount (1%).

In CRM, the competition has caught up
It has happened all that often in recent memory, but St. Jude Medical (NYSE:STJ) and Boston Scientific (NYSE:BSX) have closed a bit of the gap with Medtronic in pacemakers and ICDs. Where Medtronic saw ICD revenue up 1% and pacing revenue down 2%, St. Jude was up 7% and 1% and Boston Scientific was up 1% and 7%.

Looking ahead, I don't see it getting any easier for Medtronic. St. Jude will be launching its new Quartet NXT leads and will likely give a lot of marketing support to its Nanostim leadless pacemaker. For Boston Scientific, it's about the S-ICD product that offers reliable sensing and therapy without the need for transvenous leads. Medtronic has not been ignoring the CRM space, as it has been working on a leadless pacing system and has been ahead of the curve with MRI-safe devices, but it looks as though Boston Scientific has finally righted the ship and St. Jude has established some legitimate momentum in the space.

Disappointments in the clinic
Investors were rightly disappointed when Medtronic's IN.PACT Amphirion drug-coated balloon (DCB) failed in a trial for below-the-knee peripheral vascular disease. That puts even more pressure on strong results from the pivotal study of the IN.PACT Admiral DCB in the superficial femoral artery, with data expected soon. While Bard's initial trial data for its Lutonix balloon in the SFA was disappointing and confusing, I believe one-year follow-up for the Lutonix will be positive and will establish a tough hurdle rate for Medtronic in a market that could be worth up to $1 billion with good pricing. 

Far and away the bigger disappointment was the failed efficacy trial in renal denervation and the very uncertain future for this product. Rival Covidien has punted on this space and it is unclear how Boston Scientific and St. Jude will proceed from here. At a minimum, the once-gaudy projections of a $3 billion for renal denervation in 2020 are likely null and void.

CoreValve is a core growth opportunity
In contrast to those clinical setbacks, Medtronic's transcatheter heart valve (CoreValve) looks like the real deal and a serious threat to Edwards Lifesciences (NYSE:EW). The CoreValve was approved for sale by the FDA faster than expected, and the clinical data have been compelling. Although patients who get the CoreValve seem to require pacing at a higher frequency than that seen in studies of Edwards' Sapien, the major stroke and paravalvular leak rates have been impressive.

At one month, 2.4% of CoreValve patients considered "extreme risk" for surgery experienced a major stroke, versus 5% for the Sapien (Edwards) and around 2% for Lotus (Boston Scientific). The one-year rates also favor CoreValve over Sapien (4% versus over 10%). On the subject of moderate-to-severe leaks, the one-month leak rate for the CoreValve was 11.5% (declining to 4.1% at one-year), while the Sapien patients have seen a one-month rate of 16.9% and a one-year rate of 20.9%. Lotus seems to really excel here, with a one-month leak rate of 1.9%.

There are a lot of sub-markets (high risk, moderate risk, et. al) within transcatheter valves and a newer Edwards product (the Sapien XT) to consider, but I think the point holds that Medtronic has a competitive product here and good odds of a multibillion dollar annual revenue opportunity. That assumes that Edwards does not win injunctions blocking them from the U.S. market for patent infringement, but the history in the U.S. suggests Edwards may win royalty payments instead of an outright banning of the CoreValve from the market.

The bottom line
I'm only looking for slightly more than 3% annual revenue growth for Medtronic over the next decade, which is meaningfully less than what I expect from St. Jude (5%), Boston Scientific (4%), Edwards (5.6%), Bard (3.8%) and other large med-techs. I likewise see relatively less incremental margin or FCF generation potential for Medtronic, but FCF growth of slightly more than 3% still supports a fair value of about $60.50 today for Medtronic shares.

As I discount cash flows on a required return basis, I believe Medtronic is priced to generate annual total returns of around 12%, and that is well above the typical returns of the S&P 500. That makes Medtronic an interesting value call today in a market sector that is seriously lacking in major value these days.

These 3 stocks may have an even better run ahead
It's no secret that investors tend to be impatient with the market, but the best investment strategy is to buy shares in solid businesses and keep them for the long term. In the special free report "3 Stocks That Will Help You Retire Rich," The Motley Fool shares investment ideas and strategies that could help you build wealth for years to come. Click here to grab your free copy today.

Stephen D. Simpson, CFA has no position in any stocks mentioned. The Motley Fool owns shares of Medtronic. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers