A Member of Pat McKeough’s Inner Circle recently asked for his advice on the world’s largest provider of medical devices.
Pat likes the firm’s market leadership and its heavy investment in research. Ventilator sales will be a steady revenue stream until a COVID-19 vaccine is found. However, Pat notes the virus will likely slow sales of its other products in the near term.
Q: What are your thoughts on the long-term prospects of Medtronics plc, a maker of medical devices including ventilators? Thanks.
Medtronic plc, (Symbol MDT on New York; www.medtronic.com), develops, manufactures, distributes, and sells a wide range of healthcare-related devices and equipment. Based on revenue, the company is the world’s largest medical device provider.
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It operates in 140 countries and employs over 86,000 people. For tax purposes, Medtronics makes its head office in Dublin, Ireland, but has its operational headquarters in Fridley, Minnesota.
The company operates in four segments: the Cardiac and Vascular Group (35% of total revenue) includes pacemakers, defibrillators and cardiac resynchronization therapy devices; the Minimally Invasive Therapies Group (23%) sells surgical products, such as surgical stapling devices, vessel sealing instruments, wound closure, and electrosurgery products, as well as ventilators; the Restorative Therapies Group (35%) offers products for spinal surgeons, neurosurgeons, neurologists, and other specialized surgeries; and the Diabetes Group sells insulin pumps, consumables, and glucose monitoring systems (7%).
Roughly 53% of the company’s sales are from the U.S., 32% from developed countries outside the U.S., and 15% from emerging markets.
Over the past five years, Medtronic’s total revenue increased 50.7%, from $20.3 billion in 2015 to $30.6 billion in 2019 (fiscal years end April 30) while earnings increased 47.9%, from $4.8 billion ($4.28 per share) to $7.1 billion ($5.23 per share).
The growth was driven by several large acquisitions: HeartWare International Inc, a maker of implantable mechanical circulatory devices and heart pumps, was purchased in 2016 for $1.1 billion; and Mazor Robotics, a spine surgery innovator based in Israel, was acquired in 2018 for $1.7 billion.
In the three months ended January 24, 2020, the company’s revenue increased 2.3%, to $7.72 billion from $7.55 billion, a year earlier. Excluding one-time items, earnings improved 11.3%, to $1.95 billion, or $1.44 a share, from $1.75 million, or $1.29.
These quarterly results don’t reflect the COVID-19 outbreak and the resulting economic shutdown that has impacted businesses worldwide.
Medtronic’s $24.7 billion in long-term debt is a low 20% of its market cap. It also holds $11.0 billion in cash and investments.
Inner Circle: Heavy R&D spending growth maintains market leadership
The company operates in a competitive global industry against the likes of Johnson & Johnson, Philips Healthcare, GE Healthcare, and Siemens. However, Medtronic continues to defend its market leadership by investing in research and by acquiring innovative technology.
Since 2015, R&D expenses have increased, rising from $1.6 billion to $2.3 billion (8% of sales) in 2019. That represents a 43.8% rise and has helped the company to continue releasing innovative medical technology. For example, Medtronic leads in the development of micro-electronic, ultra-low-power medical devices. That includes a new type of pacemaker that’s the size of a large vitamin capsule.
The company also acquires innovative technologies by purchasing the firms that develop them. Recent purchases include Titan Spine, a titanium spine implant technology firm; AV Medical, a developer of medical interventions based on catheters; Stimgenics, a maker of a spinal cord stimulation used to treat chronic pain; and Digital Surgery, a surgical simulation, data, and analytics platform.
Medtronic has gained media attention during the COVID-19 crisis as a leading manufacturer of ventilators, which it sells under the Puritan Bennett and Newport brands. The company has been ramping up ventilator production and expects to produce more than 1,000 per week by the end of June. That’s a five-fold increase over pre-pandemic levels.
Together with Intel (symbol INTC on Nasdaq and a recommendation of our Wall Street Stock Forecaster newsletter), Medtronic is working to develop remote capability for one of its ventilators. That would let clinicians avoid unnecessary contact with patients.
In mid-April 2020, the U.S. Department of Health and Human Services announced contracts for ventilator production under the Defense Production Act. Medtronic’s contract, with a value of $9.1 million, is for 1,056 ventilators to be produced by June 22. Another 200 are due May 4 and 678 by June 1.
Ventilator sales will be a steady revenue stream for Medtronic until a COVID-19 vaccine is found. However, the market opportunity is dampened somewhat by Medtronic’s decision to publicly share the design specifications for one of its ventilator models so that manufacturers around the world can accelerate ventilator production. As well, the company has vowed not to raise ventilator prices. While this will hold back profits, it should give the company considerable goodwill with government regulators in the future.
In the near term, the coronavirus outbreak will slow Medtronics’ sales. Hospital resources are being diverted to fight the pandemic, and many government agencies in conjunction with healthcare systems have made decisions to defer many elective and semi-elective procedures that use the company’s products. In addition, some people are avoiding seeking treatment for non-COVID-19 emergency procedures, resulting in an impact to those product lines. In the current environment, capital equipment purchases by hospitals, outside of ventilators and patient monitors, are also being deferred.
However, longer term, tapping into key trends like an aging population and greater wealth globally all bode well for Medtronics’ share price and investor returns. Technological changes that continually spur new product development will also pay off. Meanwhile, the stock offers investors a 2.5% yield.
Recommendation in Pat’s Inner Circle: Medtronic plc is a buy.
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