What follows is a list of medical equipment companies that I find have minimal downside. I am most optimistic about Medtronic largely due to its strong gains in return on invested capital - the driver of value creation. Another attractive healthcare pick that I am even more optimistic about is InVivo Therapeutics (OTCQB:NVIV), which offers a biopolymer scaffolding device for treating spinal cord injuries. It has established significant barriers to entry through positive trial results and IP protection. These two companies should outperform more general medical device companies, like Boston Scientific and St. Jude Medical, which are characterized by greater competition and mutliple headwinds.
Medtronic trades at a respective 12.5x and 10.5x past and forward earnings with a dividend yield of 2.5%.
Consensus estimates for Medtronic's EPS are that it will grow by 2.4% to $2.45 in 2012 and then by 8.1% and 6.2% more in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $3.60, the rough intrinsic value of the stock is $50.42, implying 30.3% upside. Second quarter revenue represented a 6% gain and marked the fifth time in a row that Medtronic delivered stable growth. EPS of $0.84 was also slightly ahead of consensus due to greater-than-expected margins and a lower tax rate. Label expansion for CRT-D into Class II NYHA patients will also help expand free cash flow.
Medtronic also has several other reasons why it will outperform peers. For one, its sales trajectory has been predictable and thus a quicker-thank-expected full recovery would generate high returns. Average PE mutiple levels have historically been around 23 over the last 8 years, but it is now unreasonably nearly half of that. Free cash flow has never been negative over the last 10-year period, and the payout has also been less than 60%. Dividends have been available since 1977 and are consistently raised, which showcases management's confidence over the fundamentals.
Boston Scientific (BSX)
Boston Scientific trades at a respective 20.6x and 12.4x past and forward earnings.
Consensus estimates for Boston Scientific's EPS are that it will grow by 7.1% to $0.45 and then by 8.9% and 12.2% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS of $0.47, the rough intrinsic value of the stock is $6.58, implying 10.2% upside. Boston Scientific's Element platform has demonstrated greater LC risk than Medtronic's stents. With that accepted, this risk is acceptable since the product has strong radial strength.
The main reason why I believe Boston Scientific is likely to underform Medtronic, however, stems from the possibly $1.4B structured deal for the private company Cameron Health. The target owns a defibrillator, which is believed to help catalyze recently poor momentum in that segment for Boston Scientific. However, I am very concerned about the regulatory headwinds that this will bring form the FDA and possible dilution from failed execution. Although the device has been implanted in 1K Europeans, no trial has been conducted in Americans. Should the device fail to meet domestic regulatory standards, it will make accretive takeover activity in the future difficult for Boston Scientific.
St. Jude Medical (STJ)
St. Jude trades at a respective 17.3x and 11.8x past and forward earnings with a dividend yield of 2.1%.
Assuming a multiple of 17.3x and a 2013 EPS of $2.70, the rough intrinsic value of the stock is $46.71, implying 7.5% upside. I am optimistic about the firm's focus on unmet needs in renal denervation, Parkinson's, and migraines. The firm's transcatheter heart valve will struggle to perform due to Medtronic and Edwards Lifesciences (EW) leading reign on the market.
Part of the reason why the company will underperform Medtronic is due to the degree of safety that has been factored into the stock price. As the economy improves, investors will be more willing to back riskier stocks. St. Jude has consistently penetrated the defibrillator market and is likely to continue to do so at least over the next 3 years. By that time, a full recovery is likely to have materialized. When market share gains begins to stagnate, or even fall, this will disillusion investors and cause them to look elsewhere.
Additional disclosure: The distributor of this research report is not a licensed investment adviser or broker-dealer. Investors are cautioned to perform their own due diligence. We seek business relationships with all of the firms in our coverage, but research covered in this note is independent and prospectively commissioned.