Shareholders of medical technology company Medtronic (NYSE: MDT) got a bonus last night. Besides an earnings report, the company also provided a financial outlook for 2006 through 2008.
The outlook appears ironic at first, because fourth-quarter sales, compared with last year's fourth quarter, were up a measly 4.2% (to be fair, the sales total is a record). Net earnings, before a gigantic $630.1 million in special charges, came in 10.1% higher compared with last year's figure net of special charges. Neither result measured up to the long-term forecasted outlook of 15% annual revenue and earnings growth.
Earnings' failure to hit the 15% growth target can be easily explained -- there was one fewer week in the latest fourth quarter. An extra week, all things being equal, would have produced roughly 8% higher growth in net income, assuming earnings were spread evenly across weeks. So earnings were fine, but revenue for the quarter was on the light side when viewed next to targets.
The quarter, which ended April 29, also marked the end of the company's 2005 fiscal year. For the year, revenue increased 10.7% to a record high, and net earnings, minus special charges, rose 13.7%. Account for one fewer week in fiscal 2005, tack 1.9% onto revenue growth figures (again, assuming even revenue distribution across weeks), and revenue is still a bit short.
Medtronic is a rare company. When Motley Fool co-founder Tom Gardner recently wrote about finding The Next Home Run Stock, he used Medtronic to show great past performance. In January 1990, the stock sold for a split-adjusted $2.00 a share. It is 26 times higher today.
Medtronic is still worth owning today. There are impressive market-share gains over the past year, and there is reason for the company's positive outlook. But the stock -- trading at 28.4 times trailing earnings (fully diluted and excluding special charges) -- is also trading at almost twice the expected growth rate. Is it worth that?
Compounding earnings 15% a year would yield $2.83 a share in 2008 (using the adjusted net income, net of charges, as a baseline -- it's my math but within the company's $2.70 to $2.90 forecast) and a much more reasonable stock price at 18.7 times forward earnings. Still, in 2008, the stock's price-to-earnings ratio exceeds the growth rate -- valuing the company at something in excess of fair value.
Don't overlook the balance sheet. The debt-to-equity ratio, at a lean 23.5%, leaves Medtronic with lots of borrowing power to make an acquisition, if that makes sense. Further, the company is flush with cash -- enough to support the whole of its long-term obligations and then some, or finance expansion.
A quick look at competitors says Wall Street likes Medtronic. Boston Scientific (NYSE: BSX) and Johnson & Johnson (NYSE: JNJ) are growing earnings significantly faster, thanks to new coated-stent products -- a market Medtronic is expected to enter next year. Still, Boston Scientific sells for 20.5 times trailing earnings, Johnson & Johnson for 22.7 times trailing earnings.
Add it up. The stock became a 26-bagger by growing consistently. But with a growth rate of almost half the current price-to-earnings ratio, the stock is hardly value-priced.
Fool contributor W.D. Crotty owns shares of Medtronic and Boston Scientific. Click here to see
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