Having made a habit of defending St. Jude Medical (NYSE:STJ) as it navigated its way through a lull in growth, doubts about its clinical pipeline, and the controversy over its Riata leads, it feels a little strange to complain that the shares now appear to be overvalued. And yet, even though I'm bullish on the prospects for products like Portico, MediGuide, CardioMEMS, and Nanostim, it's hard to come up with a realistic set of growth expectations that suggest these shares are too cheap today.
Earnings As Advertised
St. Jude Medical largely revealed its fourth quarter results prior to a presentation at a major health care conference earlier this month, so today's release was not all that surprising.
Revenue rose about 4% as reported and 6% on an organic constant currency basis, and that was a solid beat (around 3%) relative to the prior sell-side expectations. Importantly, St. Jude outperformed almost all the way across its business units.
Sales from its Cardiac Rhythm Management, or CRM, unit were up 6% this quarter, with a strong (7%) rebound in ICDs. With this, I think it is safe to say that any questions about St. Jude's leads and competitive share loss to Medtronic (NYSE:MDT) as a result have been largely put to bed. It's challenging to judge the ICD market because Medtronic reports on a different fiscal calendar (October quarter ICD sales were up 3%) and Boston Scientific (NYSE:BSX) hasn't reported yet, but I would be surprised if St. Jude isn't gaining share in the ICD market.
Continuing on, Cardio sales were up 7% due in large part to strong tissue valve sales, while atrial fibrillation sales growth of 8% was the one real disappointment this quarter particularly given the performance at Johnson & Johnson and the hope that new catheters in 2013 and the MediGuide system would support results. In contrast, neuromodulation (up 8%) continues to do pretty well despite the overhang of an FDA warning letter.
Margin performance wasn't great, but it wasn't a major influence on net results. Gross margin fell more than a point from last year and missed the average sell-side guess by about a point, but St. Jude underspent on SG&A to a similar degree and the operating margin was more or less on track as operating income fell about 5%.
Two Significant Products Should Get Their Start In 2014, And A Third Should Develop
After two years in a row of consummately "blah" revenue growth performance, St. Jude needs to get back on a growth trajectory. Investors are looking to CardioMEMS and Nanostim for some of that growth. St. Jude expects to acquire the remainder of CardioMEMS this year, and this implantable monitoring device could generate hundreds of millions of dollars in revenue from the congestive heart failure market in three or four years.
Nanostim is likely to be a small contributor to 2014 results, but as the first leadless pacemaker to market, it will be important for St. Jude to maximize the opportunity before Medtronic follows with its own device (perhaps as early as 2015 in Europe). The single-chamber pacemaker market is estimated to be worth upwards of $600 million, and I would expect St. Jude to push hard to gain share from Medtronic and Boston Scientific in the pacemaker space.
2014 will also be an interesting year for the Portico transcatheter heart valve and the EnligHTN renal denervation system. Many analysts have been very down on the prospects for Portico gaining any meaningful share against Medtronic or Edwards Lifesciences in Europe, and outperformance here would be most welcome. The future of EnligHTN is even harder to address; the company stopped its U.S. pivotal study for fear that it couldn't recruit patients against the Medtronic device, only to see Medtronic report that it's pivotal study was a failure. With Covidien recently deciding to bail on the OneShot as well (despite encouraging early stage data), I really do not know what St. Jude is going to do next with this platform.
The Bottom Line
Many things could go right for St. Jude over the next three to five years. The company could continue gaining share in ICDs, CardioMEMS and Nanostim could be big hits, and products like Endosense, Portico, and Amplatzer -- which just had its U.S. study stopped for a redesign -- could all exceed expectations.
The problem is that a lot of that is already in the shares. Even a forecast of 5% long-term revenue growth and 10% long-term free cash flow grow only points to a fair value in the mid-to-high $50's, and the combination of significant payer pushbacks and competition from companies like Medtronic, Boston Scientific, and Johnson & Johnson argue against substantially higher revenue growth rates.
With that, I'm going to sit on the sidelines on this one. I wouldn't be in a rush to sell, but I just don't see that level of unreasonable undervaluation here that typically gets me excited about a stock.