In the realm of healthcare stocks too cheap to ignore, there are a lot of different stories to suit individual investor tastes.
Covidien (COV) is the under-appreciated and overlooked story, Stryker (SYK) is the quality story, and Medtronic (MDT) is the "yeah, growth has slowed, but not that much" story. What about St. Jude Medical (STJ), then? St. Jude is the rebound and pipeline story, a story that arguably deliver better growth than the Street presently expects.
A So-So End To The Year, As Expected
St. Jude's growth in fourth quarter came in on the lower range with the likes of Johnson & Johnson (JNJ) as opposed to stronger stories like Covidien and Stryker. Reported sales rose 4%, but organic growth was more on the order of 1% for the December quarter.
St. Jude's core cardiac rhythm management saw sales drop once again - down 4.5% this time (and down 6% in constant currency), but still more than half of the company's sales. Sales were especially weak in the U.S. (down 12%), while global sales of pacemakers and ICDs declined at more or less the same rate. With this performance, St. Jude probably held its share steady at around 30% - sandwiched between Medtronic and Boston Scientific (BSX).
Although sales growth was not especially strong, St. Jude did make progress on margins. Gross margin improved almost a point with a switch to lower-cost manufacturing sites and a more favorable sales mix. Operating income rose 9%, helped by barely any increase in R&D spending.
A Tale Of Two St. Jude's
The company's core CRM business continues to struggle. St. Jude has some definite company-specific issues (namely, worries about the quality of its leads), but the CRM market on the whole is on pace for a 5% sales decline in 2011. What's going on here is a familiar refrain across med-tech. Companies got too aggressive in promoting their products and too addicted to price hikes, while doctors got too aggressive in their practices and starting implanting ICDs in patients who arguably didn't need them.
Outside of CRM, though, the picture is a lot better. The company's cardiology business (which includes heart valves and electrophysiology) saw nearly 19% sales growth, while atrial fibrilation and neuromodulation revenues increased 13% and 12% respectively.
The Narrative Of Tomorrow
Like Little Orphan Annie, the story on St. Jude is all about tomorrow getting better. The company believes they are going to reverse 2011's poor performance and show mid-single digit growth in 2012. Some of this will come from easier comps, some from a more stable market, but also some from new products like the quadrapolar leads. That's a hefty expectation, particularly as Medtronic continues to see strong interest in its MRI-safe pacemakers (which St. Jude is also developing).
Beyond this, management also expects increasing interest in fractional flow reserve (FFR). This electrophysiology product has shown that it can significantly improve outcomes in stent procedures, but only about 10% of cases use FFR. In theory, it's a $1 billion-plus market split about 50/50 between St. Jude and Volcano (VOLC). In practice, this was a high-potential market back when I was still a sell-side analyst and it just seems painfully slow to develop.
There are some additional long-term opportunities that could be quite exciting. The company will be revealing data on its PFO repair product that it acquired with AGA Medical in the first half of 2012 and this could prove to be a $500 million with relatively little competition for a while. St. Jude is also moving forward with its own renal denervation technology, deep brain stimulation for Parkinson's and migraine, and a transcatheter heart valve.
If these products work out, they could add literally billions to St. Jude's addressable market. Now for the bearish rebuttal. PFO repair attempts have never shown much efficacy, DBS for Parkinson's and migraines has been slow to develop (and Medtronic and Boston Scientific are also there), renal denervation is starting to look crowded (again, Medtronic and others), and St. Jude may have trouble breaking the Medtronic - Edwards Lifesciences (EW) duopoly in transcatheter heart valves.
The Bottom Line
I happen to think that there's a quite a bit of potential in St. Jude's pipeline and that while not everything is going to work, there's enough coming that sales growth could accelerate nicely around mid-decade. It's also worth remembering that there's an upcoming analyst day (February 3rd) and if management handles this right, analysts may come out of this more bullish on the stock.
Healthcare stocks have actually been doing pretty well in 2012, but there's more room for St. Jude shares to go. I'm not expecting brilliant success (only mid-single-digit free cash flow growth), but that's enough to make these shares cheap enough to buy today and worth upwards of $50. Keep in mind, too, that this is with relatively conservative pipeline expectations; if the data comes on strong, the upside will be greater.