Outcome MedTech Market Movers: Amid Pandemic Headwinds, Strategic Positioning & Innovative Technology Drive Growth Outlook
By: Derrick Holmes, CFA, Analyst
Medtronic plc (NYSE: MDT) released Q3 earnings Tuesday 2/22. The stock initially jumped on the news and closed for the day up slightly over 2%. Medtronic beat consensus adjusted EPS by $0.01 and reported earnings per share of $1.37 for the quarter. Reported revenue was $7.76 Billion which was slightly below market expectations of $7.88 billion and represents a decline of 0.2% from a year earlier. On an organic basis, which excludes the impacts of foreign currency, the company had year over year revenue growth of 2%.
The Med Tech industry has continued to face pandemic headwinds such as health care labor shortages and large declines in medical device procedure volumes which has resulted in underwhelming performance. Over the last twelve months Medtronic stock has declined approximately 11%, which lagged that of the S&P500 by around 20% over the same period. However, it is not all doom and gloom for Medtronic as there seems to be light at the end of the COVID-19 tunnel.
“We expect healthcare procedures to reaccelerate post-Omicron, and our commitment to durable and higher growth remains steadfast”, Geoff Martha, Medtronic Chairman and CEO
Medtronic has been in the process of implementing a lean business model over the past 18 months. The revamped business strategy has improved the company’s pace and ability to bring products to market which has translated into market share gains across multiple segments. There have also been improvements made to capital allocation decision making which can be displayed through an increase in Medtronic’s Return on Assets (ROA). Year over year, ROA has improved from 2.51% to 4.76%. In other words, for every dollar that the company invests into assets it can generate about $0.047 of earnings, up almost 90% from the prior year.
Medtronic has made significant investments into R&D throughout the current fiscal year. With a target budget of over $2.7 billion allocated to R&D in FY2022, this is a 10% increase representing the largest dollar increase in R&D spend in the company’s history. Management has also shown commitment to M&A by supplementing the current pipeline of products with several attractive tuck-in acquisitions. Over the fiscal year, Medtronic has announced 8 acquisitions totaling over $3.2 billion. This figure includes last month’s notable acquisition of Affera Inc., a deal with total consideration of $925 million. The transaction is subject to certain conditions and is expected to close in the first half of 2023. Affera is focused on treating cardiac arrhythmias and has mapping technology that will be strategically utilized to fill a product gap in Medtronic’s cardiac segment, and more specifically increase the capabilities of their ablation business. Affera currently is seeking FDA approval as their product portfolio is not yet available for commercial use. This deal is not unique to the med tech industry as early-stage companies within high growth segments are often strategically acquired by larger players to strengthen their product portfolios and pipelines. As the industry continues to revive post COVID, companies like Medtronic that have managed to maintain strong balance sheets will look to M&A for growth and business development opportunities as valuations have recently come down a bit.
Medtronic’s cardiovascular portfolio is their largest business portfolio and currently generates about 35% of the company’s total revenue. Within Medtronic’s medical surgical portfolio, the surgical innovations segments recorded an impressive year over year organic growth rate of 9.2% this past quarter and is the largest contributor to overall top line growth. Medtronic continues to pave the way in surgical robotics with a limited market release of Hugo; a robotic surgical device that has performed surgeries in Latin America and India and is awaiting approval and undergoing clinical testing in several countries including the US. Although Medtronic has a first mover advantage, the surgical robotics market is plagued with high costs and utilization barriers, which have kept adoption rates low. Within Medtronic’s neuroscience portfolio, the company has continued to see strong growth prospects in Brain Modulation. Medtronic seems to have a competitive advantage in this space, capturing about 10% of new implant share and over 1% share in the overall deep brain stimulation market over the third quarter alone.
Management has communicated a clear path for shareholder value and has a commitment to return more than 50% of free cash flow to shareholders. This will be achieved primarily through dividend payments and opportunistic share repurchases. Due to strong growth in free cash flow, up 23% on a year over year basis, and above industry average operating margins, management should feel confident in their ability to generate earnings that will sufficiently cover dividend payments to shareholders. Management has additionally provided guidance for Q4 revenue and earnings figures which are currently in line with the consensus view of 5.5% organic revenue growth and non-GAAP diluted EPS of $1.56-$1.58.
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