Investing for sustainable income is as simple as buying and holding businesses with track records of success and decades of dividend growth. This strategy filters out subpar companies because only the best are capable of delivering prolonged growth in dividend payouts.
A Dividend Aristocrat with 45 consecutive years of dividend hikes to its credit, Medtronic (MDT -1.41%) rises above most businesses when it comes to dividend stability and growth. But can this dividend growth streak continue? And is the stock a buy for income investors? Let's dig into Medtronic's fundamentals and valuation to answer these questions.
Long-term fundamentals intact despite a tough quarter
In late August, the medical devices juggernaut shared its financial results for its first quarter of fiscal year 2023. This was an especially challenging quarter: Revenue came in at $7.4 billion, down 7.7% year over year. While this appears to be quite bleak for such a well-established business, the headline revenue figure is deceiving. This is because unfavorable foreign currency translations stemming from a stronger U.S. dollar accounted for a $351 million decline in revenue. Adjusting for this factor, Medtronic's revenue decline was a more modest 3.3% year over year.
It's important to note that during the quarter, Medtronic faced several headwinds aside from foreign currency translations. First, supply chain shortages affected the company's surgical innovations business. Next, Medtronic's ventilator sales were skewed higher in the year-ago period. And finally, abnormally high procedure volumes following the third wave of COVID-19 a year ago lifted the company's revenue artificially, because many procedures were delayed and rescheduled to work around that wave to free up hospital capacity for treating COVID-19 patients.
Medtronic generated $1.13 in non-GAAP (adjusted) diluted earnings per share (EPS) in the first quarter, down from $1.36 in the year-ago period. What was behind this uncharacteristic dip, besides lower revenue?
Inflation in labor and materials and a strengthening dollar were the primary drivers of a 264-basis-point drop in Medtronic's non-GAAP net margin to 20.4% for the first quarter. This was only slightly offset by a 1.6% reduction in the company's share count to 1.3 billion, which was due to share repurchases.
Yet despite the difficult quarter Medtronic just experienced, the stock's investment thesis remains intact. The company's culture of innovation is attested by the fact that its products received over 200 regulatory approvals throughout the world over the past 12 months. As supply chain issues dissipate and Medtronic continues to launch new products, the company should have no problems growing. This is why analysts anticipate that Medtronic's adjusted diluted EPS will grow at a compound annual rate of 12.7% over the next five years.
Image source: Getty Images.
A dividend that can run higher
Medtronic's 3.1% dividend yield crushes the S&P 500 index's 1.6% yield. And income investors don't just benefit from higher immediate income: Medtronic is poised to also deliver robust dividend growth.
The company's dividend payout ratio is positioned to be about 49% for the current fiscal year. This is a balanced payout ratio that both rewards shareholders and allows the company to improve its business through debt reduction and bolt-on acquisitions. This is why I expect at least high-single-digit annual dividend growth from Medtronic for the foreseeable future.
An appealing valuation
Medtronic's forward price-to-earnings (P/E) ratio of 14.8 is well below the medical devices industry's average forward P/E ratio of 23. Medtronic's relatively low valuation is puzzling when considering that its 12.7% annual earnings growth forecast is essentially in line with the industry average of 12.9%.
Even the best businesses in the world fall on hard times every now and then. This seems to be what's happening with Medtronic. Fortunately, the market's impatience with the stock has arguably created a great buying opportunity for long-term investors.
