Medtronic Delivering Dividends Through Emerging Markets

| About: Medtronic plc (MDT)

Typically, when you think of medical device companies focusing on the eastern part of the globe, you think of the relocation of manufacturing to lower cost through cheaper labor and supplies. Due to a growing middle class, China and India are no longer just a cheap labor play for U.S. outsourcing but a growing consumer base that will purchase more health services in the future. One of the best plays on this emerging growth trend is Medtronic, Inc. (NYSE:MDT).

Known as a prolific dividend grower, Medtronic is one of the world s leading medical technology companies, specializing in implantable and interventional therapy devices and products. Medtronic is positioning itself to profit from the international growth of medical devices which will improve earnings per share ([EPS)) and provide more dividend increases in the future.

Make no mistake about it, the U.S. is still the most profitable market for medical device makers but the market has become stagnant in the past few years. China's medical-device market will expand by 15% to 20% through 2015 from $7.5 billion in 2010, forecasts Pacific Bridge Medical. It is expected that within the next decade, China will be the biggest healthcare market in the world, outpacing the U.S.

Further boosting demand is a growing number of Chinese with health insurance. From 2009 to 2011, China's Ministry of Health invested $124 billion in the Chinese healthcare market. A large part of this went to bolster China's expanding medical insurance system.

Accordingly, the medical device market in India grew to $3 billion by the end of 2011. According to a recent report, that figure should more than triple over the next ten years, to reach $10 billion by 2022. While India's market grows at this fast pace, its regulators are looking to overhaul how medical devices are registered and marketed in their country.

Meanwhile, private healthcare spending in India is also expanding rapidly to meet the needs of the country's growing middle class, which has both rising disposable income and increasing medical expectations. On the supply side, the Indian government has labeled pharmaceutical and medical device sectors as priority areas for its 12th five-year plan starting in 2013.

In 2012, Medtronic acquired a Chinese orthopedics maker and opened a research and development center in Shanghai. The company plans to hire 1,000 workers in China and more than 600 in India over the next five years, even as it moves to cut 1,700 positions from its global workforce.

Medtronic reported third-quarter fiscal 2013 EPS of $0.97, up 10% year over year. After taking into account certain one-time items, the adjusted EPS was $0.93, up 11% year over year and ahead of the analyst consensus estimate of $0.91. Revenues were $4.027 billion in the quarter, up 3% year over year or up 4% at constant exchange rates (CER). However, it was lower than the analyst consensus estimate of $4.032 billion.

Medtronic management confirmed that both the ICDs and spine markets are gradually stabilizing, which will result in easier comparisons and should improve growth over the coming quarters. The improvement continued in the first half of 2013 as well. Medtronic encouragingly noted that, in the last reported quarter, growth in both of these markets was relatively stable leading to share gain.

Medtronic derived 46% of its total sales from the international market, which climbed 8% year over year at CER (up 5% as reported) to reach $1.856 billion. As a result of the company's focus on emerging markets, revenues from these regions experienced continued growth momentum and increased 20% (21% at CER) to $475 million. This region now represents 12% of the company s total revenue.

Additionally, Medtronic had market share gains due to the recent launch of Resolute Integrity drug eluting stent ((NYSEARCA:DES)) for the treatment of coronary artery disease, even in patients with diabetes mellitus. Significantly, it is the only DES approved for use in diabetic patients. Strong customer acceptance of the stent led to tripling its market share over the past three quarters. Besides, share in the international market should increase further with the strong performance of Resolute Integrity in the $500 million Japanese DES market.

Medtronic has a current dividend yield of 2.33%. The company has a 5-year average dividend growth rate of 15.77%. If this dividend growth rate is sustained from growing profits in the emerging markets, the dividend will double in 4.5 years. The current dividend payout ratio is only 30% so there is significant room to increase the dividend payout in the future.

According to the long-term capital deployment policy, Medtronic expects to generate $25 billion in free cash flow over the next five years and will return 50% to shareholders through dividends and share repurchases. The company repurchased $614 million shares in the reported quarter, representing 1% of total outstanding shares and is now left with authorization to buy back 31 million shares. A better-than-expected share repurchase activity could further drive the bottom line of the company.

Medtronic is reasonably priced with a price earnings (NYSE:PE) ratio of 13.63 compared to the industry average PE of 18.57. Medtronic could easily benefit from a rising PE ratio as it delivers on the growth of emerging markets.

First Call analysts' consensus has Medtronic with 2013 EPS of $3.69 and 2014 EPS of $3.86. Based on its current PE, Medtronic has a 12-month price target of $50. First Call analysts' consensus has a "buy" recommendation on Medtronic with a 2.3 rating.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.