Can Medtronic PLC (NYSE:MDT) Deliver The Promise?

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  1. Medtronic targets revenue growth of up to 5.5% in the current quarter.
  2. Management targets $850 million in cost synergies by 2018.
  3. Medtronic looking for free cash flow of $25 billion in the next five years.

Medtronic PLC (NYSE:MDT) reported a mixed F3Q2016 in which revenue missed expectations and EPS barely matched the Wall Street target. The company is battling pressures of intense competition, economic slowdown and adverse forex movements. In the last quarter, forex caused a $344 million revenue headwind.

Medtronic is looking to Covidien to drive revenue growth in the coming years. Management is also looking to cost curtailment boost margins.

This Medtronic analysis article examines the company’s strengths and challenges to enable you make informed investment decision regarding this medical devices stock. However, first is a quick recap of last quarter’s earnings and performance outlook for the coming periods:

F3Q2016 highlight

Medtronic PLC (NYSE:MDT) posted adjusted EPS of $1.06, which met the consensus estimate but declined 0.9% from a similar quarter a year ago. Revenue reading of $6.934 billion for the quarter was up 6% YoY, but missed $7.051 billion that analysts were looking for on the average.

The chart below shows Medtronic’s revenue vs. cost of revenue for the last five quarters:

 Capture

Outlook

Medtronic guided for percentage revenue growth in the band of 5% to 5.5% in the current quarter. Forex headwind is expected to wipe up to $220 million of the quarter’s topline.

For fiscal year 2016, Medtronic is looking for EPS in the range of $4.36 to $4.40. The previous EPS target for the year was $4.33 to $4.40.

Areas of interest

Medtronic PLC (NYSE:MDT)’s management has made some promises and here are some of the areas that investors will be following developments closely.

  • Investors will be looking to see if successful integration of Covidien can help drive revenue and contribute to the $850 million in cost synergy expected by 2018.
  • Over the coming quarters and especially at the reporting of the current quarter, investors will be looking for signs that new product launches canboost market share gain or at least stem market share loss.
  • The coming quarters will also see investors glued to the progress of cost reduction that the management is hoping will help lift margins.
  • Competition in the Spinal and CRDM segments has intensified in the recent times. Investors will be looking for signs of proof of sustainable in those segments.

What’s exciting about Medtronic?

  1. Market share gain

Covidien adds unique capabilities to Medtronic PLC (NYSE:MDT) that should help the company gain share in the medical devices market and also accelerate expansion in emerging markets. Medtronic is targeting to be the leader in medical technology and services in at least 150 countries. The acquisition of Covidien brings it closer to that dream.

  1. Market stability

The cardiac rhythm and heart failure (CRHF) market is showing indications of greater stability in 2016 than 2015. With that, Medtronic should have more growth drivers over the next several quarters compared to the previous ones.

  1. Expansion into TMVR market

Medtronic PLC (NYSE:MDT) recently completed the acquisition Twelve, Inc. for $458 million. The acquisition will see Medtronic expand into the lucrative transcatheter mitral valve replacement (TMVR) market. About 1.7% of the U.S. population was found to have TMVR problem in 2014.

According to data compiled by GlobalData, the transcatheter aortic valve replacement (TAVR) is expected to grow at compound annual growth rate of 19.7% between 2013 and 2020 to reach $3 billion by the end of the forecast year.

The TAVR market growth figures can be used to understand the potential in TMVR market for Medtronic. The population of patients with TMVR is usually about four times that of TAVR. As such, there is huge growth opportunity for Medtronic by expanding into the market.

  1. Increased focus on emerging markets

Medtronic’s emerging markets business grew 14% in the last quarter and contributed about 190bps to the consolidated revenue growth. That was within the management’s target of between 150 bps and 200bps.

Looking deeper into last quarter’s financial results you see that while macroeconomic pressures took the luster out of Medtronic’s overall results, growth in the emerging markets was solid.

Going ahead, the management has demonstrated renewed efforts to drive growth in emerging markets and also already highlighted, Covidien is expected to play a role in that growth.

China is on top of Medtronic’s emerging markets priorities. It is predicted that the next decade would see China surpass the U.S. as the single largest healthcare market in the world. Further growth is expected in the EMEA region, which has recently shown positive growth signs.

  1. Cost reduction

The management of Medtronic PLC (NYSE:MDT) is focused on trimming costs to at least cope with pricing pressures. Successful cost reduction should also pave the way for margins expansion.

The management is targeting to generate $850 million in cost synergies by 2018. In the current fiscal year (2016), the target is to capture between $300 and $350 million in cost synergies with the rest being realized over the coming years.

Besides contributing to topline growth, the integration of Covidien is also expected to support cost reduction, thus boosting margins.

  1. Prudent capital deployment

Medtronic is targeting to raise $25 billion in free cash flow in the coming five years. That compares with $17 billion it raised in the last five years. Of the free cash flow expected, the management has committed to return 50% to shareholders in the forms dividends and repurchases. Besides funneling 50% of free cash to shareholder returns, the target is to sweeten dividends by 400% within the next couple of years.

What’s worrying about Medtronic?

  1. Currency translation headwind

Adverse foreign exchange rate movement in the last quarter wiped $344 million of revenue. The trend is expected to continue with the management modeling adverse impact of between $180 and $220 million on revenue in the current quarter.

In an environment where competition for market share has become tough and economic slowdown is grinding, losing $220 million to forex headwind adds to the pain.

  1. Tough competition

The wave of competition has continued to grow strong in the medical devices market. Not only are existing players strengthening their positions, but newcomers are also adding to the competition complication. Medtronic PLC (NYSE:MDT) competes mainly with St. Jude Medical, Inc. (NYSE:STJ) and Boston Scientific Corporation (NYSE:BSX) in the CRDM segment.

But it is also facing growing competition from Johnson & Johnson (NYSE:JNJ) and in the Spinal segment.

Medtronic generates the majority of its revenue from Spinal, CRDM and Cardio Vascular segments.

  1. Soft healthcare spending

Adverse macroeconomic conditions have seen hospitals trim their budgets, affecting purchase and utilization of medical devices. Continued weakness in hospital spending could make it difficult for Medtronic PLC (NYSE:MDT) to hit its growth targets.

Conclusion

As much as there are strong headwinds for Medtronic PLC (NYSE:MDT) to contend with in the coming quarters, solid management execution could help mitigate the pressures and pave way for more growth across the various categories.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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