If your heart doesn’t pump with a regular rhythm, you’ve got a serious problem. But if so and you’re still reading this, it may be because you’re a customer of the cardiovascular rhythm management (CRM) industry. In this case, those initials don’t refer to the “customer relationship management” version of CRM, where companies like Salesforce.com (with its ticker of NYSE:CRM) work.
This CRM sector makes devices that doctors implant in your chest that create an electric shock to get your heart pumping if it gets off track. And the industry is big — although shrinking. A decision to invest in it comes down to the prospects for the stocks of two CRM leaders, Medtronic (NYSE:MDT) and St. Jude Medical (NYSE:STJ).
According to Medtech Insight, the global CRM market is likely to total $11.4 billion in revenue this year, down 2% from 2010. The reason for the decline: research that argues CRM products are misused and a Department of Justice investigation into the industry.
A January 2011 study in the Journal of the American Medical Association claimed that “a substantial percentage of US physicians may not be following evidence-based guidelines” for CRM devices. Though its findings are controversial, the study suggests that some patients may be getting the devices even though that might not be the best treatment for what ails them.
And if that wasn’t bad enough, there’s an ongoing Justice Department investigation into whether health care providers are improperly billing Medicare for CRM devices. Specifically, the agency is trying to gather evidence concerning whether providers are improperly billing Medicare for ”nonqualified [implantable cardioverter defibrillators] ICD implants.” reports Medtech Insight.
Medtronic and St. Jude are big players in this industry. Medtronic has 45% of the U.S. ICD market and St. Jude has 27%. But JPMorgan analyst Michael Weinstein sees a rapidly contracting market: He expects the U.S. ICD market to decline at a 5.2% annual rate, from $4.18 billion in 2010 to $3.38 billion in 2014.
Medtronic has been affected by this contraction. And that contributed to low expectations for its fiscal second-quarter 2012 results, reported early Tuesday. FactSet-polled analysts were expecting earnings of 82 cents on revenue of $4.07 billion. The EPS expectations for Medtronic’s report were the same as for the same period in 2010, while the revenue forecast was up 4.4% from the year before.
Medtronic’s actual result was better than expectations, and the stock is up 3.5% in Tuesday morning trading. Revenue was $4.13 billion — $40 million higher than forecast and EPS of 84 cents was two cents more than forecast.
St. Jude has been performing even more impressively. When it reported results in October, its adjusted EPS of 78 cents for the third quarter beat expectations by six cents a share. And its revenues increased 11.5% to $1.38 billion — beating the Zacks Consensus Estimate by around $10 million. Although St. Jude had problems in its CRM product line, other products offset the bad news.
So here’s what the investment choice between Medtronic and St. Jude boils down to:
- Medtronic: barely growing, wide margins; expensive stock. Medtronic sales have risen 0.7% in the past 12 months to $16.2 billion, while net income has slipped 0.1% to $3.1 billion — yielding an impressive 19.1% net profit margin. Its PEG of 1.37 (where a PEG of 1.0 is considered fairly priced) is expensive on a P/E of 11.6 and expected earnings growth of 8.5% to $3.73 in fiscal 2013.
- St. Jude: growing, wide margins; expensive stock. St. Jude sales have sales have risen 10.3% in the past 12 months to $5.56 billion, while net income has increased 16.8% to $907 million — yielding a solid net margin of 16.3%. Its PEG of 1.34 is expensive on a P/E of 12.9 and expected earnings growth of 9.6% to $3.58 in 2012.
Medtronic and St. Jude are overvalued on a PEG basis, given their slow expected earnings growth. If forced to choose, I would pick St. Jude because it’s growing faster. In light of the never-ending drip of nasty global debt rumors, keep an eye on St. Jude for an opportunity to buy its shares at a lower price.
Peter Cohan has no financial interest in the securities mentioned.