Medtronic (MDT) delivered a solid Q1 F2020 with above consensus EPS growth. The company should continue to thrive in the long-term thanks to (1) its rich innovative pipeline, (2) an ageing world population, and (3) a strong balance sheet. The company currently pays a 1.9%-yielding dividend and is trading at an attractive valuation. We think the company is a good investment choice for investors with a long-term investment horizon seeking both capital appreciation and dividend growth.
Recent Developments: Q1 F2020 Financial Highlights
Medtronic delivered a solid Q1 F2020 with revenue growth of 3.5% thanks to outperformance in 3 of its 4 segments. Its operating margin expanded by 90 basis points thanks to its initiatives to constrain growth in its SG&A expenses. Therefore, its diluted EPS increased by 7.7% to $0.64 per share. The growth rate was much higher than the revenue growth rate of 3.5% mentioned earlier. As can be seen from the chart below, the company has consistently delivered results that beats the consensus in each of the past 12 quarters.
What we like about Medtronic and its business
We continue to like Medtronic and its business for the following reasons:
A rich innovation pipeline
Medtronic typically spends about 7.5% of its total sales (about $2 billion ~ $2.5 billion) on R&D expenses each year. This enables it to continue to introduce innovative medical devices and solutions to meet the needs of the healthcare industry. The company has a diverse portfolio of products. As some legacy products gradually retire, there are always innovative products introduced to replace the lost revenue from these legacy products. Below are some of its innovation pipeline in each of the three main segments: cardiac and vascular group (“CVG”), restorative therapies group (“RTG”), and minimally invasive therapies group (“MTG”).
Source: Investor day presentation.
Global medical device market is growing
Medtronic should benefit from a growing global medical device market. As can be seen from the following chart, global medical device market is expected to reach $409.5 billion by 2023. This represent a compound annual growth rate of 4.5%. According to a report by Lucintel:
The future of the global medical device market looks good, with opportunities in public and private hospitals.
We believe Medtronic is well-positioned to capture this growth opportunity as it has a portfolio of different medical products and especially a strong presence in cardiovascular devices, which is expected to grow rapidly from 2018 ~ 2023 (see the purple area in the chart).
An aging global population will provide some tailwinds as well
The growth in global medical device market is driven in part by technology advancements as well as demand due to an aging population. The world population is actually aging quickly than many of us thinks. According to a report by UN, population aged 60 years or older is expected to more than double by 2050 from the level today. This means that there will be over 2 billion of population who are 60 years or older by 2050. This will create tremendous demand for medical devices. Being a dominant player in the space of medical devices, we expect Medtronic to continue to thrive in the next few decades.
Source: UN: World Population Aging.
Solid balance sheet to support its growth strategy
Medtronic has a solid balance sheet with a long-term debt to total asset ratio of 27.2%. Thanks to its strong free cash flow generation, Medtronic has reduced its long-term debt over the past few years. Its total long-term debt of $24.8 billion at the end of Q1 F2020 is much lower than 2015’s $33.6 billion. We believe Medtronic’s strong balance sheet will allow it to be opportunistic to make necessary acquisitions as well as continue to put resources in R&Ds to maintain its competitive position.
Source: Q1 F2020 earnings presentation.
Risks and Challenges
Medtronic’s hospital clients may face the pressure of reduction in Medicare reimbursement. Medtronic may have to sacrifice margin in order to maintain sales. The company also faces competitive pressures from other companies.
Medtronic is currently trading at a forward P/E ratio of 19.38x. This is below many of its peers who trade above 20x. For example, Abbott Laboratories (ABT) and Stryker (SYK) trades at forward P/E ratios of 25.5x and 27.2x respectively.
A growing 1.9%-yielding dividend
Medtronic has increased its dividend consistently in the past decade even during the time of the Great Recession. The company currently pays a quarterly dividend of $0.54 per share. This is equivalent to a dividend yield of 1.9%. The company’s dividend is sustainable with a low payout ratio of 39% (based on the midpoint of its F2020 EPS guidance). We think the company will be able to continue to increase its dividend in the next few years.
We like Medtronic’s rich innovation pipeline and its growth outlook. Its shares are still attractive at this price. We think the company can be a good long-term holding for investors with a long-term investment horizon. However, given the fact that its shares have surged considerably in the past year, we think any pullback will provide a better buying opportunity.
Disclosure: I/we 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.
Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.