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From inelastic demand to breakout revenue projections, the healthcare sector provides some of the most attractive risk/reward prospects. Occasionally, there are a few bad apples, such as in Hospira (NYSE:HSP). This biotech company has met an enemy in the form of the FDA and receives bearish sentiment on the Street. Covidien (NYSE:COV), a medical equipment and supplies, provides much less uncertainty and has delivered excellent upside. Based on my multiples analysis and DCF model, I find that Covidien is a substantially more attractive play in healthcare than Hospira.

From a multiples perspective, Covidien is the cheaper of the two. It trades at only 12.2x and 9.9x past and forward earnings while offering a dividend yield of 2%. Hospira does not offer a dividend yield and trades at a respective 20.3x and 12.2 past and forward earnings. Between these two is the less volatile Baxter, which trades at ar respective 13.5x and 11.1x past and forward earnings. While Hospira really cannot be compared to these healthcare companies due to different markets, the point is to illustrate the marked contrast.

At the third quarter earnings call, Hospira's CEO, Mike Ball, noted began his speech by addressing the manufacturing debacle:

"Rocky is a large facility that accounts for approximately 25% of our overall net sales. It produces generic injectables, large-volume solutions and also is one of the facilities that supports our contracting manufacturing business…

Rocky Mount is under a Warning Letter from the FDA, which we received in April of 2010, related primarily to processing compliance issues. An FDA inspection completed in June 2011 resulted in observations from the FDA known as a 483. The FDA completed another inspection in August 2011, after which we received a second 483 with additional observations.

Receiving 2 483s so close together was a clear signal that we were not making satisfactory progress to fully comply with the FDA's concerns, and that we needed to ramp up our remediation efforts … The situation at Rocky Mount is one we are committed to fix".

In addition to the production difficulties, Hospira is also have other trial issues. POSIDUR's Phase III failure, unfortunately, has the effect of masking effort elsewhere to reduce Precedex generic risk. The company may seek acquiring new business to inject life into the franchise and should focus more on adding late-stage products. At the same time, a transaction would be dilutive to EPS and - coupled with tremendous uncertainty - could be the impetus that causes many investors to exit.

Consensus estimates for Hospira's EPS forecast that it will decline by 9.1% to $3.01 in 2011, decline by 16.3% in 2012, and then grow by 20.2% in 2013. Assuming a multiple of 14.5x and a conservative 2012 EPS of $2.41, the rough intrinsic value of the stock is $34.95, implying 10.9% upside. If the multiple declines to 12.5x - at the low-end of peers - and 2012 EPS turns out to be 7.5% below consensus, the stock would fall by 7.6%.

Turning to medical devices and equipment, Covidien presents an attractive buying opportunity. The company had excellent performance in the fourth quarter with sales beating expectations, adjusted EBITDA soaring by 29%, and operating margins notably expanding. The top-line grew in the double-digits in Latin America, Europe, and Asia. The ev3 acquisition yielded $0.05 accretion to EPS by unlocking revenue and cost synergies. Management also took the right step in seeking to spin-off its complex ~$2B pharmaceuticals business, which will better allow investors to appreciate its value.

Consensus estimates for Covidien's EPS are that it will grow by 7.3% to $4.26 in 2012 and then by 8.5% and 9.3% more in the following two years. Assuming a multiple of 14.5x and a conservative 2013 EPS of $4.57, the rough intrinsic value of the stock is $66.27, implying 45.6% upside. Modeling a CAGR of 8.4% for EPS over the next three years and then discounting backwards at a WACC of 9% yields roughly the same value. Accordingly, Covidien is easily a "strong buy".

Source: Why Covidien Will Surge 50% As Hospira Struggles