I'm a dividend investor, which is why I jumped at the chance to buy Medtronic (MDT 0.37%) when its yield spiked toward historically high levels this year. The problem is that I'm definitely not a healthcare stock specialist, generally preferring to outsource investment decisions in this sector, which is driven by highly technical issues, by owning a sector-focused closed-end fund.
I made an exception here because Medtronic is a Dividend Aristocrat. And then the company announced it was spinning off a division, potentially upending my thesis. After some further analysis, I've decided I'm not worried about the move. Here's why.
A great record
When I look at a stock one of the first things I want to know the consistency and frequency of its dividend increases. As we all know, you can't predict the future from historical performance, but I believe a commitment to a steadily increasing dividend shows that management is running its business well and believes in rewarding shareholders for the company's success. Medtronic's annual dividend increase streak is up to 45 years. While that "only" makes it a Dividend Aristocrat right now, it appears to be steadily working its way toward Dividend King status. You simply don't achieve a record like this by accident.
Image source: Getty Images.
This is where the core business comes in. Medtronic makes medical devices across four major areas, including surgery (surgical robots), cardiovascular (pacemakers), neuroscience (brain stimulators, which is a vast simplification), and diabetes (blood sugar monitors). That's a fair amount of diversification and it made me more comfortable with the company, knowing that no single business line was a make-or-break affair. This fact, added to the dividend history and historically high yield, got me to push the buy button.
The high yield, and thus weak stock price, meanwhile, appeared to be driven by what seemed like near-term issues. For example, Medtronic was delayed in its effort to release its surgical robot in the United States. And it has been dealing with regulatory pushback on a key product in its pipeline. However, management was very clear that it believes it can work through these issues, which means that the long-term benefits of these new products are merely delayed. Given the history here and the size and scale of the company, I'm willing to accept that, even if it is a slow process. I'll happily reinvest the historically large 3% or so dividend while I wait.
And then everything changed
But then management did something that set my nerves on edge -- it announced plans to spin off its respiratory interventions and patient monitoring businesses into a new company. It's a $2.2 billion revenue business, so this is no small change. In fact, that's about 7% of the company's revenue, which is no small figure. When companies make moves like this they sometimes adjust the dividend lower, using the spin-off as an excuse. Upon reading the news my fear was that a dividend cut was coming.
I quickly worked through the slides the company provided on the spin-off, and management clearly stated that it does "not expect this separation to impact Medtronic's dividend policy." That information, however, was revealed on the very last line of the very last page of the presentation. Needless to say, my pulse was a bit elevated by the time I found this important gem. But, having found this vital (to me) news, I was able to go back and take a closer look at what was going on. And it's a net positive.
Basically, Medtronic is looking to focus more on growth. The two healthcare businesses it is spinning off aren't bad, but they are slower growing and have more modest margins than other areas of its business. Just separating these operations out should be a help on both the growth and profitability front. However, the longer-term hope is that the move will free up the company to focus even more effort on faster-growing and more profitable businesses, thus boosting Medtronic's long-term prospects. That's a perfectly reasonable expectation. And if Medtronic can do that without putting the dividend at risk, I'm all for it.
Room to play
The company's first-quarter 2023 adjusted earnings dividend payout ratio was a healthy 60%. That means there's ample leeway for the company to make a move like this without investors having to worry too much. Add management's historical commitment to the dividend and its statement that the spin-off won't change the dividend policy, and dividend investors like me, who perhaps aren't healthcare specialists, should probably feel very comfortable that this move is going to lead to better things ahead.
