About two weeks ago, I wondered whether the Street had caught up to Covidien (UNKNOWN:COV.DL). Apparently the answer is "no", as the company once again beat expectations with strong sales growth and particularly strong performance in its core surgical business.

I still don't think Covidien is particularly cheap, but that's a complaint I make a lot these days in the health care sector. On a relative basis, I think Covidien, Johnson & Johnson (NYSE:JNJ), and Stryker (NYSE:SYK) are above-average calls on a relative basis, as they're exposed to improving procedural growth across multiple markets.

Coming through again
Covidien continues to burnish its reputation as an under-promise/over-deliver sort of company, as fiscal first quarter revenue rose 3% on a reported basis, 5% on an organic basis, and eked out a 1% beat versus the average of sell-side estimates. Covidien also broke out its growth on a regional basis, with growth in the U.S. of 3%, developed OUS markets of 5% (local currency) and 14% in emerging markets.

Surgical Solutions was the growth leader this quarter, with 8% revenue growth split between 10% growth in the Advanced Srugical division and 3% growth in General Surgical products. That compares favorably with the 4% growth in Specialty Surgery from Johnson & Johnson this quarter (and the 2% decline in Surgical Care), not to mention the 10% US procedural growth at Intuitive Surgical.

Vascular Therapies saw less robust growth (up 5%), with 5% growth in Peripheral and 4% in Neurovascular. Covidien continues to lack Stryker in neurovascular sales (Stryker's sales were up almost 10% this quarter) and it's hard to tell how Covidien is doing relative to AngioDynamics in endovenous therapy since AngioDynamics indicated that sales were up "more than 20%", while Covidien had "strong double digit growth".

Respiratory and Patient Care was a mixed bag. Overall sales growth of 2% was on target, but Patient Care (down 1%) and Nursing Care (up 4%) were better than expected, while Patient Monitoring (up 6%) was a little weaker than expected and Airway/Ventilation (down 4%) missed by almost 10%.

Unlike most other med-tech companies that have reported so far, Covidien was pretty clean on margins. Gross margin declined half a point from last year, but was a half-point better than expected. Operating income fell 1% due in large part to higher R&D spending, but the operating margin was a point stronger than expected.

Two more deals to build the emerging market opportunity
Although emerging markets were the growth leaders for Covidien this quarter, their total contribution of 15% of revenue is a little on the low side relative to peers. Management is taking steps to address this, including the acquisition earlier this month of WEM Equipamentos Electronicos, a Brazilian manufacturer of electrosurgical generators and disposables, and the formation of a majority-owned JV with China's Changzhou Kangdi Medical Stapler. Neither of these deals will bring in meaningful revenue or products, but they do give the company a bigger footprint in two hugely important markets where Covidien will need to introduce more local products in the coming years.

As a quick reminder, emerging markets like Brazil and China are pretty well situated with respect to basic medical equipment like ventilators, though both countries are likely to be adding hospitals and hospital beds at a rate meaningfully higher than in developed markets. Where Covidien has its biggest opportunities in these markets is in areas like minimally invasive surgery, where penetration rates are very low and potential cost savings are high.

Careful for now, but with large opportunities down the road
Covidien seems cautious about raising guidance commensurate with this quarter's performance, and that's not all that surprising given their past behavior. Even so, I think the outlooks of Covidien, Johnson & Johnson, Stryker, and Intuitive Surgical are consistent with a relatively healthy surgical procedure market in the U.S. and E.U. this year.

Covidien also still has interesting opportunities for longer-term growth. Management made the unexpected decision to shut down its renal denervation program (even though Covidien's OneShot had strong pilot study data), but opportunities in therapeutic areas like Barrett's esophagitis, lung cancer, and advanced minimally invasive tools are all potentially worth more than $1 billion each.

The bottom line
I expected more out of Covidien that the sell-side, so I'm making only minor tweaks to my model. I'm still expecting long-term free cash flow growth in the high single digits, and I believe that is worth about $69 per share today.

As I said in the beginning, Covidien isn't all that cheap but it is a high-quality company with potential revenue and margin upside. I may be reluctant to establish a new full-sized position at these levels, but I'd still rank at as one of the best picks in med-tech on a relative risk-reward basis.