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Third Quarter Flashback

Minnesota-based medical devices major St. Jude Medical (STJ) produced a mixed bag in the third quarter beating earnings expectations, but missing on the revenue front. Adjusted earnings of 72 cents per share topped the Zacks Consensus Estimate of 68 cents (representing a 5.88% positive surprise) while net income zoomed roughly 25%, buoyed by revenue growth across the board.

Revenues rose 7% year-over-year to $1,240 million, but trailed the Zacks Consensus Estimate of $1,247 million. Growth was led by healthy ICD sales which spiked 13% to $439 million. However, the encouraging ICD growth, by some measure, was masked by yet another sluggish performance by the pacemaker business.

St. Jude’s Atrial Fibrillation and Neuromodulation franchises remained on the growth track with revenues rising 8% and 11%, respectively. Moreover, effective cost-management fuelled operating margin expansion.St. Jude raised its earnings forecast for fiscal 2010.

Agreement – Estimate Revisions
Earnings estimates for St. Jude have gushed up following the third quarter results, reflecting a strong bullish sentiment. Estimates for fiscal 2010 depict an absolute directional concurrence with 23 analysts currently covering the stock raising their forecasts over the past week with no movements in the reverse direction.

For fiscal 2011, 23 (out of 31) analysts have lifted their estimates over the last 7 days while just 1 made a negative revision. A similar trend applies for annual estimates over the past month.

The optimism among the analysts reflect improved earnings visibility, encouraging growth prospects in the company’s core ICD business through its expanded product range, a favorable device replacement cycleand improved operating leverage. The strong positive opinion not only exerts a meaningful impact on the Zacks Rank, but also reflects the potential for significant upward pressure on the stock.

Magnitude – Consensus Estimate Trend
The escalating estimates coupled with a comprehensive directional consensus have led to a significant rise in annual earnings forecasts for St. Jude. Estimates for fiscal 2010 and 2011 have gone up by 8 cents and 5 cents, respectively, over the last week. The current Zacks Consensus Estimate for 2010 is $2.99, representing an estimated 23.13% year-over-year growth.

Neutral on St. Jude
We remain intrigued by St. Jude’s ability to deliver consistent revenue and earnings growth. Moving forward, revenue growth should be supported by numerous product introductions in the U.S. and Europe. Launch of several ICD products should boost the company’s CRM market share.

St. Jude’s new Fortify and Unify lines of ICDs are already gaining notable traction. The company currently holds a 25% share in the global ICD market and is poised to expand its position through increased penetration with these new devices.

Neuromodulation represents another lucrative platform for St. Jude, which offers spinal cord stimulators in this nascent but fast-growing market. Growth in this segment will be fostered by the adoption of the company’s deep brain stimulation (DBS) systems and sustained uptake of the Eon Mini SCS system. In the third quarter, St. Jude commenced the full roll-out of its DBS product in Europe for Parkinson’s disease.

St. Jude is well positioned to savor incremental opportunities in its Cardiovascular businesson the back of its acquisition of medical technology firm LightLab Imaging, which has enabled it to enter the fast-growing intravascular imaging market.

Also, the recent launch of a new manufacturing plant in Costa Rica is expected to boost production of St. Jude’s heart valve products and augment the manufacturing capacity of its Cardiovascular division. The company is entering the $500 million market for pericardial stented tissue valves with its Trifecta line of valves scheduled for launch in the U.S. in mid-2011. This represents another exciting new growth prospect for the Cardiovascular business.

In a major move, St. Jude recently struck a deal to acquire heart devices maker AGA Medical Holdings for $1.3 billion. The transaction, which is expected to close by end-2010, is expected to considerably strengthen St. Jude’s Atrial fibrillation and Cardiovascular franchises. The acquisition will make St. Jude a leading player in the structural heart market.

St. Jude and its peers Medtronic (MDT) and Boston Scientific (BSX) are increasingly in a tug-of-war to grab CRM share. Competition is set to intensify as Medtronic introduces its new ICD and pacemaker devices, which are currently awaiting final regulatory approval.

St. Jude recently pared its fiscal 2010 CRM market growth forecast and there is a lack of near-term visibility for material recovery. We feel a soft CRM market may prove to be challenging for the company at least through fiscal 2010.

While we are encouraged by St. Jude’s solid fundamentals, strong product mix and healthy growth trajectory, we remain wary about competition-driven pricing pressure and the heightened competition in a mature pacemaker market.

Moreover, we are cautious about the dilutive impact of acquisitions and any unfavorable currency exchange fluctuations on the bottom line. This is reflected in our Neutral recommendation for the stock, which is supported by a Zacks #3 Rank (Hold).

Source: Earnings Scorecard: St. Jude Medical

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