While the S&P 500 has surged 27% year to date amid the economic recovery, shares of the leading medical device stock Medtronic (MDT 1.69%) have tumbled 13% over the same period. With Medtronic's stock less than 5% off its 52-week low, this raises the following questions: Is Medtronic now a buy? Or should investors remain on the sidelines?
Let's take a look at potential reasons for Medtronic's underperformance, its operating fundamentals, and its valuation to tackle these questions.
Industry uncertainty and increased regulatory scrutiny
There are two potential reasons to explain Medtronic's poor stock performance as of late. First, it's important to reiterate how Medtronic generates its revenue and profits. The company sells medical devices around the world that treat a variety of chronic health conditions, including gastrointestinal diseases, heart ailments, and diabetes.
But since the advent of COVID-19, many hospitals have been busy treating COVID-19 patients, delaying the elective procedures in which Medtronic's devices are used. This has been a headwind on Medtronic's financial results at various points throughout the pandemic. And with the omicron variant rapidly spreading, hospitals may again have to defer elective procedures, which could be yet another hit to Medtronic in the near future.
Second, Medtronic recently received a warning letter from the U.S. Food and Drug Administration (FDA) earlier this month relating to quality concerns at the headquarters of its diabetes business in Northridge, California. Although it's likely that Medtronic will work diligently with the FDA to resolve concerns surrounding its MiniMed and Paradigm insulin pumps, this event exacerbated the stock's decline in recent trading.
Medtronic is admirably navigating challenging conditions
While Medtronic's second-quarter 2022 earnings report was mixed (its fiscal year will end in April 2022), the company is doing well considering that it has contended with COVID-19 headwinds. Medtronic reported $7.85 billion in revenue during the second quarter, which represented a 2.6% growth rate against the year-ago period. This fell slightly short of analysts' expectations of $7.98 billion in revenue for the quarter. What was the reason behind Medtronic's revenue miss?
Paraphrasing Chairman and CEO Geoffrey Martha's opening remarks during Medtronic's recent earnings call, strength in international markets was more than enough to offset headwinds in the U.S. market caused by the delta variant and health system staffing shortages. Medtronic's international revenue grew 7.2% year over year in the second quarter, while its U.S. revenue shrank 1.4%. The company's strong showing in international markets was what led its revenue to drop just 2% over the previous quarter, which Martha noted as "slightly better than most of our large-cap medtech competitors."
Cost efficiencies helped Medtronic to improve its operating margin by 470 basis points, which is what powered its non-GAAP earnings per share (EPS) 29.4% higher year over year to $1.32 in the second quarter. Medtronic's non-GAAP EPS came in a bit higher than the $1.29 analysts forecasted.
The company has a culture of innovation
Even with the pandemic weighing on Medtronic, the company has managed to launch more than 180 products in the U.S., Western Europe, China, and Japan over the past 12 months. This speaks volumes about the cutting-edge culture that Medtronic has fostered. And this innovation doesn't appear as though it will be ending anytime soon. That's because Medtronic remains committed to spending over $2.7 billion on research and development this fiscal year, which would be a 10%-plus increase over last year.
Medtronic's skill in launching such large quantities of game-changing medical devices spells out why analysts are projecting that the stock will deliver 11% annual earnings growth over the next five years.
A Dividend Aristocrat to buy confidently
Despite the adversity facing the medical devices industry over the past couple of years, Medtronic's fundamentals appear to be healthy. But is the valuation attractive enough to justify buying the stock?
At its current $104 share price, Medtronic is trading at a forward price-to-earnings (P/E) ratio of just 18.3. This is significantly lower than the medical devices industry average forward P/E ratio of 29.3. Given that Medtronic's projected five-year earnings growth rate is only moderately lower than the industry average of 15%, arguably there is room for meaningful upside at the current valuation. In fact, the analyst consensus seems to point to tremendous upside as well, with a 52-week target price of $135 a share.
As an S&P 500 component that has raised its dividend for 44 consecutive years, Medtronic is a Dividend Aristocrat. With the dividend payout ratio set to be 44.1% for this fiscal year, investors can collect Medtronic's safe, market-beating 2.5% yield while they wait for the market to assign a higher valuation multiple to the stock.