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Medtronic, Inc.
(MDT-NYSE)
SUMMARY
SUMMARY DATA
Risk Level *
Low
Type of Stock Large-Blend
Industry Med Products
Zacks Industry Rank * 182 out of 267
Current Recommendation
NEUTRAL
Prior Recommendation
Underperform
Date of Last Change
09/05/2011
Current Price (02/19/14)
$56.20
Target Price
$59.00
Medtronic reported third-quarter fiscal 2014 adjusted
EPS of $0.91, down 2% year over year and in-line with
the Zacks Consensus Estimate. Revenues came in at
$4.163 billion, up 4% at CER, closely beating the Zacks
Consensus Estimate of $4.155 billion. After a several
quarters of improvement, the company s core ICD and
pacing segments posted disappointing sales. Spine
revenues continue to maintain sluggish trend. However,
strong CoreValve transcatheter aortic heart valve sales
in the international market were encouraging. Besides,
focus on portfolio expansion with objective to boost
revenues from emerging markets is encouraging. We
are also looking forward to the company s recent attempt
to rebuild it as a health care service provider. However,
looming headwinds such as currency headwinds, soft
economic condition and tough competition keep us on
the sidelines. Currently we are Neutral on the stock.
52-Week High $60.84
52-Week Low $43.88
One-Year Return (%) 27.55
Beta 1.00
Average Daily Volume (sh) 5,362,547
Shares Outstanding (mil) 998
Market Capitalization ($mil) $56,107
Short Interest Ratio (days) 2.06
Institutional Ownership (%) 29
Insider Ownership (%) 0
Annual Cash Dividend $1.12
Dividend Yield (%) 1.99
5-Yr. Historical Growth Rates
Sales (%) 2.8
Earnings Per Share (%) 5.6
Dividend (%) 8.5
P/E using TTM EPS 14.8
P/E using 2014 Estimate 14.7
P/E using 2015 Estimate 13.7
Zacks Rank *: Short Term
1 3 months outlook 3 - Hold
* Definition / Disclosure on last page
ZACKS CONSENSUS ESTIMATES
Revenue Estimates
(In millions of $)
Q1 Q2 Q3 Q4 Year
(Jul) (Oct) (Jan) (Apr) (Apr)
2012
4,049 A 4,132 A 3,918 A 4,297 A 16,184 A
2013
4,008 A 4,095 A 4,027 A 4,459 A 16,590 A
2014
4,083 A 4,194 A 4,163 A 4,588 E 17,018 E
2015
4,265 E 4,391 E 4,333 E 17,652 E
Earnings Per Share Estimates
(EPS is operating earnings before non-recurring items, but including
employee stock options expenses)
Q1 Q2 Q3 Q4 Year
(Jul) (Oct) (Jan) (Apr) (Apr)
2012
$0.79 A $0.84 A $0.84 A $0.99 A $3.46 A
2013
$0.85 A $0.88 A $0.93 A $1.10 A $3.75 A
2014
$0.88 A $0.91 A $0.91 A $1.12 E $3.82 E
2015
$0.95 E $0.99 E $0.99 E $1.17 E $4.10 E
*Note: Quarterly EPS may not add up to the annual figure due to rounding-off.
Projected EPS Growth - Next 5 Years % 7
February 20, 2014
Equity Research MDT | Page 2
RECENT NEWS
In-Line Earnings, Tighter Outlook at Medtronic
Feb 18, 2014
Medtronic s third-quarter fiscal 2014 adjusted EPS came in at $0.91, down 2% year over year but in line
with the Zacks Consensus estimate. The year-over-year decline was primarily due to the non-renewal,
this year, of a benefit of $0.03 from the extension of the U.S. R&D tax credit.
Also, high interest expense and the U.S. medical device excise tax lowered the bottom line in the
reported quarter. However, without any one-time adjustments, the company reported net income of $762
million or 75 cents a share, both down 23% on year-over-year bases.
Revenues in the reported quarter were $4.163 billion, up 3% year over year (up 4% at constant exchange
rates or CER). The result remained marginally above the Zacks Consensus Estimate of $4.155 billion.
International sales (generating 46% of total sales) grew 2% year over year (up 4% at CER) to $1.898
billion in the quarter. Based on Medtronic s focus on emerging markets, revenues from these regions
experienced continued growth momentum and increased 10% (up 12% at CER) to $521 million. This
region now represents 13% of the company s total revenue.
Segment Details
Medtronic earns revenues from two major groups
the Cardiac & Vascular Group and the Restorative
Therapies Group. The former encompasses the Cardiac Rhythm Disease Management (CRDM),
Coronary, Structural Heart, and Endovascular businesses; while the latter includes the Spine,
Neuromodulation, Diabetes, and Surgical Technologies businesses.
CRDM sales were up 1% year over year (up 2% at CER) to $1.184 billion. Revenues from Implantable
Cardioverter Defibrillators (ICD) increased 1% at CER to $655 million on the back of strong adoption
ofthe Viva XT CRT-D that drove growth in Western Europe and Japan. Pacing system revenues edged
down 2% at CER to reach $439 million. AF solutions on the other hand, grew 20% primarily due to a
stupendous 30% improvement in the Arctic Front CryoAblation System.
Coronary revenues remained flat year over year at $436 million. On the other hand, Structural Heart and
Endovascular recorded growth of 4% (to $281 million) and 4% (to $218 million), respectively, at CER.
The company is benefiting from the sale of the drug eluting stent (DES), which grew 5% at CER driven by
significant share gains of the Resolute Integrity drug-eluting stent worldwide.
Strong CoreValve transcatheter aortic heart valve sales in the international market led to growth in the
Structural Heart business. As expected, in the reported quarter, Medtronic received U.S. approval of
CoreValve for extreme risk patients. On the other hand, Endovascular growth was negatively impacted
by the divestiture of a reentry catheter product line and elimination of a peripheral below-the-knee
product from the market.
Spine revenues maintained the sluggish trend and fell 1% year over year (flat at CER) along with a flat
Core Spine revenue growth to $631 million. Excluding sales of balloon kyphoplasty, Core Spine grew in
the low single digits, both globally and in the U.S.
Moreover, BMP (bone morphogenetic protein) revenue declined 1% at CER to $113 million. According to
Medtronic, after several quarters of drag in sales, the global and U.S. spine markets have started
showing signs of stability.
Meanwhile, Surgical Technologies revenues were $386 million (up 10% year over year and up 11% at
CER), while revenues at Neuromodulation were $478 million (up 7%, same at CER) and at Diabetes,
$436 million (up 16%, same at CER).
Equity Research MDT | Page 3
Margins
Gross margin during the reported quarter contracted 41 basis points (bps) to 74.8%. Adjusted operating
margin contracted 52 bps year over year to 30.1%, with a 3.8% increase in selling, general and
administrative expenses (to $1.454 billion), a 4.3% decline in research and development expenses (to
$360 million) and a huge 164.7% decline in Other expenses (to $45 million).
Guidance
Medtronic tightened its EPS outlook for fiscal 2014. The company currently expects full-year EPS in the
range of $3.81 $3.83 (implying annualized growth of approximately 6%) from earlier prediction of
$3.80 $3.85 (annualized growth of 6% 8%).
However, the company restated its revenue growth outlook for fiscal 2014 at 3% 4% at CER. The
current Zacks Consensus Estimate for EPS stands at $3.82 (on revenues of $17.022 billion) and remains
within the guided range.
VALUATION
Medtronic posted a mixed fiscal third quarter with in-line EPS and a revenue beat. After a strong fiscal
second quarter performance with improvement in core CRDM and pacing segments, the company is
again back on its sluggish revenue track with its core segments. The still sluggish CRDM sales with poor
ICD and pacing revenues once again raised question on the company s statement of stability in core
market. Margin pressure too poses a major cause of worry. Spine sales continued its sluggish trend.
Moreover, headwinds such as unfavorable currency movement and global economic uncertainties
remain. However, Medtronic is trying every means to boost growth. This includes penetration into the
international markets, and expansion of portfolio and restructuring initiatives, which should benefit the
company over the long term.
Meanwhile, Medtronic has increased its focus on the emerging markets and is targeting higher revenues
from this region. The company is also committed to its aim of returning 50% of its free cash flow to its
shareholders, along with undertaking suitable acquisitions, to augment growth. Given the challenges
related to economic uncertainty and tough competitive landscape, we reiterate our Neutral
recommendation on the stock with a target price of $59.00.
Medtronic s current trailing 12-month earnings multiple is 14.8x compared to the industry average of 27.2
and 18.0 for the S&P 500. Our target price is based on 14.4x our 2015 EPS estimate of $4.10.
Equity Research MDT | Page 4
Key Indicators
P/E
F1
P/E
F2
Est. 5-Yr
EPS Gr%
P/CF
(TTM)
P/E
(TTM)
P/E
5-Yr
High
(TTM)
P/E
5-Yr
Low
(TTM)
Medtronic, Inc. (MDT) 14.7 13.7 7.0 11.9 14.8 15.0 9.7
Industry Average 26.1 69.8 15.0 26.7 27.2 N/M 12.6
S&P 500 15.7 14.7 10.7 14.9 18.0 27.7 12.0
Baxter International Inc. (BAX) 13.5 12.6 8.5 11.8 14.9 15.9 10.5
Covidien plc (COV) 17.8 15.9 10.2 13.7 18.1 17.3 10.7
TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow
P/B
Last
Qtr.
P/B
5-Yr High
P/B
5-Yr Low
ROE
(TTM)
D/E
Last Qtr.
Div Yield
Last Qtr.
EV/EBITDA
(TTM)
Medtronic, Inc. (MDT)
3.0 3.6 2.2 21.1 0.5 2.0 10.0
Industry Average
34.3 34.3 34.3 N/M 0.3 0.3 N/M
S&P 500
4.8 9.8 2.9 25.4
2.1
Equity Research MDT | Page 5
Earnings Surprise and Estimate Revision History
NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET
Equity Research MDT | Page 6
OVERVIEW
Medtronic, Inc. (MDT) is one of the world s leading medical technology companies, specializing in
implantable and interventional therapy devices and products. Founded in 1949, the company is based in
Minneapolis, Minnesota. Medtronic derives revenues from two broad groups
Cardiac and Vascular
Group and Restorative Therapies Group. While the former is comprised of Cardiac Rhythm Disease
Management (CRDM), Coronary, Structural Heart and Endovascular businesses, the latter includes
Spinal, Neuromodulation, Diabetes, and Surgical Technologies. In January 2012, Medtronic sold its
Physio-Control business to Bain Capital.
The Cardiac and Vascular Group's products include pacemakers, implantable defibrillators, leads and
delivery systems, ablation products, electrophysiology catheters, products for the treatment of atrial
fibrillation, information systems for the management of patients with CRDM devices, coronary and
peripheral stents and related delivery systems, therapies for uncontrolled hypertension, endovascular
stent graft systems, heart valve replacement technologies, cardiac tissue ablation systems, open heart
and coronary bypass grafting surgical products.
Products in the Restorative Therapies Group cover various areas of the spine, bone graft substitutes,
biologic products, implantable neurostimulation therapies and drug delivery devices for the treatment of
chronic pain, movement disorders, obsessive-compulsive disorder (OCD), overactive bladder, urinary
retention, fecal incontinence and gastroparesis, external insulin pumps, subcutaneous continuous
glucose monitoring (CGM) systems, products to treat conditions of the ear, nose, and throat, and
advanced energy products. Additionally, this group manufactures and sells primarily image-guided
surgery and intra-operative imaging systems.
Revenue breakup
30%
20%
11%
7%
5%
10%
9%
8%
CRDM Spinal
Coronary Structural Heart
Endovascular Neuromodulation
Diabetes Surgical technologies
56%
44%
US International
Source: Company reports
Equity Research MDT | Page 7
REASONS TO BUY
Signs of stability in core ICDs market:
Trends in the previous fiscal have been divergent for
Medtronic. While 75% of the business grew at 8%, almost 25% of the rest of the business declined
10%. However, management confirmed that both the global core ICDs markets are gradually
stabilizing. This would result in easier comparisons and should improve growth over the coming
quarters. More significantly, in the second quarter, ICD revenue growth was 4% at CER which
outperformed the market growth rate of 3% (both the global and U.S. ICD markets). ICD growth was
primarily due to the company s progress with shock reduction and lead integrity alert technologies
along with long-term lead performance leading to stronger market acceptance. In addition the ICD
implant volumes were sequentially stable for the sixth quarter in a row. The company was optimistic
about Viva and Evera which showed good market adoption. Both Viva and Evera s shock reduction
algorithms, including Medtronic s proprietary lead integrity alert were approved by the FDA recently
for monitoring the company s competitors defibrillation leads. Added to that, the company
encouragingly noted that, despite declining trend in the European ICD market due to deteriorating
pricing in some key markets, it successfully gained share in this region. We expect continued
acceptance and future growth from the Evera family of ICDs, which received CE Mark approval in
Feb 2013 and U.S. FDA and Japan PMDA approval in May 2013.
Source: Company
Focus on emerging markets to add value:
Medtronic demonstrated that while growth in the rest of
the world was low to declining, the emerging markets grew at a robust 13% (at CER) in the last
reported quarter representing more than 12% of the company s total sales mix. Although the
company experienced slower growth in this region, primarily with sequential slackening occurring in
Greater China and Central and Eastern Europe, the fundamental demand in the end market is strong.
The company is creating necessary infrastructure to participate in the next wave of growth
the
emerging market value segment.
We are encouraged about the overall growth in this region following the encouraging trend. The
recent data shows that, emerging markets on a whole for Medtronic represents a $5 billion annual
opportunity for margins compared to developed markets. Management is targeting 20% of its
revenues from the emerging markets adding incremental revenue of $2.5 billion over the next 5 years
with mid-teens growth for the current fiscal.
Medtronic has currently decided to focus on globalization due to the opportunity rife in international
destinations, especially in the emerging markets. Emerging markets continue to remain a key focus
area of the company. Accordingly Medtronic is building infrastructure necessary for it to participate in
Equity Research MDT | Page 8
the next wave of growth
the emerging market value segment. As a part of this, in Aug 2013,
Medtronic opened a global Center of Excellence (CoE) for Business Model Innovation in Singapore.
According to the company, this center will help it to address market-specific needs and barriers in
Asia. Furthermore, the company acquired China Kanghui Holdings and formed a strategic alliance
with China-based LifeTech Scientific Corporation. Medtronic believes these steps will lead to a
platform of multi-tiered products, thereby strengthening its foothold in the huge underpenetrated
Chinese market. It is expected that within the next decade, China will be the biggest health care
market in the world, outpacing the U.S. Apart from China, Medtronic intends to focus on the Middle
East which according to the company holds potential.
Product diversification holds promise: We are impressed with the company s efforts to
augment/diversify its product range. We are optimistic that over the long term, stability in the US ICD
market along with a deep pipeline/portfolio
CoreValve, Resolute Integrity, Atrial Fibrillation (AF),
renal denervation and peripheral businesses
will be the driving factors for the company going
ahead. Of these driving factors, renal denervation serves a very significant unmet clinical need in
uncontrolled hypertension and deserves special mention, given its immense market potential.
Hypertension is a primary risk factor for stroke and costs the global health care economy $500 billion
a year. Even with optimal drug therapy, 30% of the patients remain in conditions of uncontrolled
hypertension. Consequently, approximately 300 million patients would need some sort of additional
therapy by 2020. Accordingly, this indication alone holds a $2 $2.5 billion market opportunity by
2020, excluding the other potential applications of renal denervation. The company is currently
investing in developing referral networks, reimbursement, technology development, and clinical and
economic evidence, to further strengthen its leadership position and grasp the long-term opportunities
in hypertension. Medtronic expects to launch its next-generation Symplicity Spiral multi-electrode
catheter to launch before the end of fiscal 2014.
Medtronic has also witnessed robust growth in the transcatheter valve business (over 60%
compounded annual growth rate over the past two years) on the back of CoreValve. While the
product is CE Mark approved, the company is working on its launch in the U.S., scheduled in fiscal
2015. Recently, data from the CoreValve U.S. pivotal trial for extreme risk patients were presented
and the FDA decided it will conduct separate reviews for the extreme and high risk studies. It also
determined that no panel review is necessary for extreme risk approval. Given these developments,
the company expects U.S. approval of CoreValve for extreme risk patients by the end of fiscal 2014.
For high risk patients, on the other hand, Medtronic expects the FDA approval should come in by
mid-fiscal 2015. The transcatheter valve, valued at approximately $700 million last year, is expected
to grow to $2.5 billion by 2020.
Prudent use of cash:
Medtronic exited the second quarter of fiscal 2014 with $1.26 billion in cash
and cash equivalents and short-term investments, higher than $1.11 billion at the end of fiscal 2013.
Free cash flow continued to remain robust with approximately $905 million in the reported quarter.
Also Medtronic paid more than $279 million in dividends and repurchased $713 million shares. As of
the end of the second quarter, the company had remaining authorization to repurchase approximately
68 million shares. A better-than-expected share repurchase activity could further drive the bottom line
of the company. Meanwhile, having witnessed strong contribution from products that came from
acquisitions, the company will be on the lookout for suitable tuck-in acquisitions (with mid-teens
growth) with a product suite that is in sync with its portfolio.
Going by the long-term capital deployment policy, Medtronic expects to generate $25 billion in free
cash flow over the next five years ($17 billion generated in the past five years) and will strive to return
50% to shareholders through dividends and share repurchases. Attempts would also be made to
increase the proportion of cash generated in the US, as it is experiencing an imbalance with more
cash being generated outside US markets. This situation has forced the company to borrow in order
to meet its goal of returning 50% free cash flow to shareholders.
Equity Research MDT | Page 9
REASONS TO SELL
Spinal sales remained sluggish:
Medtronic s Biologics business suffered from continuous
declines in the sales of Infuse (following the publication of articles in The Spine Journal). The U.S.
core spine market continues to decline in the low single digits, with flat procedural volumes and
positive mix, partially offsetting price declines. Two systematic reviews, in articles published in the
Annals of Internal Medicine in June 2013, concluded that Infuse is an effective therapy in certain
types of spine surgery and that it entails a number of risks that should be considered by
physicians and patients. However, the results may not be of any help to Medtronic. As per the
study, Infuse showed no sign of being more effective than iliac crest bone graft. The researchers
found that, at 24 months, rhBMP-2 increased fusion rates and reduced pain by a clinically
insignificant amount and instead, increased early postsurgical pain. Evidence of increased cancer
incidence is inconclusive. We believe this frail data from the Yale study can be a big blow for the
spine product line in the coming quarters.
Excluding BKP, the core spine business was flat globally and declined 1% in the U.S., relatively in
line with the overall market. However, core spine results were below the company s expectations
as certain underperforming product lines offset the positive momentum that has been building
from new product and procedural innovations. Revenues from BMP [comprised of Infuse bone
graft [(InductOs) in the European Union) sales] declined 17% y/y at CER during second quarter
2014.
Legal Issues Hampering growth:
In Jul 2013, the German District Court of Mannheim declared that
Medtronic s CoreValve and CoreValve Evolut systems infringe Edwards Spenser patent for
transcatheter heart valve technology. This ruling forced Medtronic to recall and discontinue the sale
of the products in Germany. On Aug 26, 2013, the injunction against Medtronic s transcatheter heart
valves has gone into effect. Edwards posted a 50 million Euro bond, as mandated by the court, to
enforce the injunction. On Nov 14, 2013, the appeals court in Karlsruhe stayed the injunction based
on the likelihood that the Spenser patent would be found to be invalid. The European Patent Office
(EPO) has scheduled a hearing on March 5-6, 2014 to determine the validity of the Spenser patent.
Although, on humanitarian grounds, Edwards has allowed exceptions to the injunction ruling in
patient cases where its Sapien XT valve is not indicated, Medtronic asserted that the injunction
against CoreValve in Germany is a major setback and will hurt sales in the region. Any other adverse
regulatory action, depending on its magnitude, may deter Medtronic from effectively marketing and
selling its products.
We are also concerned about the recent U.S. Food and Drug Administration s (FDA) warning on
certain Medtronic devices. As per the announcement, the company s recently initiated voluntary field
action related to certain guidewires were classified as a Class I recall by FDA.
Competitive landscape:
The presence of a large number of players has made the medical
devices market highly competitive. Medtronic earns the majority of revenues from CRDM, Spinal
and Cardio Vascular segments. The company faces intense competition in the CRDM segment
from players such as Boston Scientific Corporation, and St. Jude Medical. Players such as
Johnson & Johnson, Stryker Corporation, Zimmer and NuVasive have made the Spinal segment
highly competitive.
Economic uncertainty affecting procedural volume:
Macroeconomic conditions in many of the
developed countries have led to reduction in healthcare budgets and increased pressure on
utilization. This leads to fewer procedures, a trend that is expected to continue in the near future
Equity Research MDT | Page 10
and affect revenue growth of the company. Growth in Europe during the reported quarter varied
with double-digit growth in France, the UK and Ireland, partially offset by softness in Southern
Europe.
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of MDT. The EPS and revenue forecasts are the Zacks Consensus
estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal
views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly,
related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this
report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to
accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet
the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an
offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a
position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the
securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to
twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve
months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The
current distribution of Zacks Ratings is as follows on the 1028 companies covered: Outperform - 14.2%, Neutral - 80.1%, Underperform
5.2%.
Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in
earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model
assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks
Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a
company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of
investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In
determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each
stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5
th
group has the highest
values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the
second, third, and fourth groups of stocks, respectively.
Analyst Urmimala Biswas
Copy Editor Anindita Sinha
Content Ed.
Lead Analyst Urmimala Biswas
QCA Souvik Guha
