The medical device industry is at the center of a battle that has consumed politics, the health care sector, and America as a whole: Obamacare.
Funding health-care reform has been a sticky subject in Washington, but the 2.3% excise tax on the sale of medical devices that went into effect this year has contributed to the law's massive bill. It's also hit many medical device companies right in the bottom line. Companies large and small have announced layoffs and projected negative financial impact from the tax.
But the tax might not be here to stay forever. It has become one of the key points of debate in Washington's fight over the government shutdown, which is tied tightly to the future of the Patient Protection and Affordable Care Act. Could ending the shutdown hinge on repealing the tax, and how will this fight hit your portfolio?
The device industry in limbo
The government shutdown standoff has divided many of Capitol Hill's lawmakers over the funding of Obamacare. The medical device tax is only a tiny portion of that proposed funding: The tax is expected to generate about $29 billion in the next 10 years and covers devices such as defibrillators, but not consumer devices such as wheelchairs. By comparison, the Congressional Budget Office estimates Obamacare's total bill at about $2 trillion over the next decade, with penalties and government savings primarily footing the cost of the legislation.
How does less than 2% of health care reform's funding become such a major sticking point in the effort to reach a political compromise over the government shutdown? Companies have cited the tax for sales drops and large job cuts since late 2012. Several of the largest device makers, such as Boston Scientific (NYSE:BSX), Medtronic (NYSE:MDT), and Stryker (NYSE:SYK), are headquartered in blue states such as Minnesota and Massachusetts, giving a handful of Democratic legislators a strong incentive to repeal the tax in order to preserve jobs and state business.
Meanwhile, numerous Republicans across the aisle are fighting for the repeal as well. The coalition of politicians has turned the tax's elimination into an issue with bipartisan support. Device companies and industry groups have chimed in as well, claiming the tax will hurt innovation in the long run due to its toll on sales, rather than earnings. That's much more damaging to small, cutting-edge start-up firms still getting their legs underneath them -- and companies such as Boston Scientific that are scrambling to get back into the black -- as compared to the industry's biggest profitable giants, which can afford to take a hit and still please investors.
Still, there are monumental challenges in front of any real chance at repealing the tax. Numerous lawmakers, particularly in the Senate, have come out against any attempt to reduce already-approved funding measures for Obamacare. President Barack Obama himself has threatened to veto a repeal of the tax. Even some supporters of repealing the tax have opined that the debt ceiling raise and the shutdown fight aren't the time to debate the issue, preferring instead to first solve the imminent fiscal problems.
However, as the government shutdown encroaches on the critical period for raising the debt ceiling -- where failure to do so this month could impact not just the U.S. economy, but investors and governments across the world -- it's not a foregone conclusion that the tax is here to stay. But we're not here to judge the ins and outs of politics at The Motley Fool -- we're here to analyze the impact of the tax on your investments. What could it mean for the device companies and investors if the levy is repealed?
The best stocks to beat Washington's chaos
For the biggest names in med tech, the device tax isn't hurting business as much as the industry would like Capitol Hill to believe.
Stryker may have cut more than 1,000 jobs last year in response to the tax, but it's not the levy that has slammed the company's earnings in 2013. True, Stryker's net earnings slipped more than 23% year over year during 2013's first six months, even as the company's sales climbed more than 3% overall. However, blame Stryker's voluntary recall of two implants, as well as restructuring and related costs, for the decline. A slow European market isn't helping the company's progress outside the U.S. either, as international sales aren't subject to the medical device tax. This stock has still jumped more than 20% year to date, and revenues are climbing at almost every segment. Stryker's hardly in danger from the device tax in the long run if it sticks around.
Ditto for Medtronic and Johnson & Johnson (NYSE:JNJ), two more of the industry's leaders. Medtronic has managed a 21.3% net margin over the trailing 12 months despite its focus on the medical device industry, and this stock's up more than 25% year to date. Government shutdown or not, Medtronic's diversity across the device sphere, from cardiac systems to spine and surgical products, safeguard the company from any specific downturns in the industry. Medtronic has campaigned against the tax, but the company's bottom line still jumped in its most recent quarter.
Like Medtronic, Johnson & Johnson's size and diversity will safeguard it against the tax in the long term. The company's device business is its largest segment by sales, but Johnson & Johnson operates across orthopedics, consumer devices, and more -- not to mention the firm's high-flying pharmaceutical division, which adds another layer of safety against this legislation. Investors in this top health care stock shouldn't worry for a second about the tax's effect on J&J's bottom line. If the tax is repealed, it will only mean a minor bump for J&J's overall performance.
Boston Scientific investors have more to worry about -- as do shareholders of the industry's many fledgling or unprofitable firms. MAKO Surgical (UNKNOWN:MAKO.DL) shareholders were bailed out by Stryker's acquisition of this innovative firm, but for most of 2013 MAKO was the standard-bearer of the potential hammer-blow of the device tax. MAKO has yet to reach profitability, and the tax on sales would have slammed the innovative company's hard road toward digging out of the red. Stryker's buy saves shareholders here, but there is no such simple resolution for Boston Scientific.
Boston Scientific CEO Michael Mahoney blamed the tax for significant job cuts earlier in the year, and even though the company has posted a strong financial performance recently, analysts still have cautioned that the levy could significantly hamper the bottom line in coming quarters. While its stock has soared in 2013, Boston Scientific only has been profitable in two out of the last four quarters and has dealt with fluctuating sales. Boston Scientific may be building a promising future, but the tax will slow down this company's drive -- and slow this stock's momentum despite an astronomical year-to-date performance. Repealing the tax would mean a much easier road ahead for Boston Scientific as it tries to consistently post positive earnings in future quarters.
Stick to the basics
Repealing the device tax would do wonders for Boston Scientific and other unprofitable or small device makers across the industry, but it's a moot point if Washington decides to leave the tax as it is. As of now, that looks like the likely option: Many political observers and market analysts expect a resolution of the government shutdown and debt ceiling raise battle to leave out a repeal of the tax.
With the uncertainty that is Washington today, investors shouldn't count on anything set in stone from Capitol Hill. However, the best bet is to look at the long term in the device industry. For the biggest players such as Johnson & Johnson and Stryker, the device tax only is a bump in the road. Strong, diversified companies like Medtronic are more appealing than ever for investors -- and establishing a strong foundation for your portfolio is the safest way to account for anything arising out of the political world. Repeal or not, sticking to investing basics and building your portfolio for the long term will bring in the financial rewards you deserve.
Fool contributor Dan Carroll has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson and 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.