Medical Device Stocks: Buy, Sell and Watch

by Will Ashworth | May 22, 2013 12:30 pm

On Tuesday, Medtronic (MDT[1]) hit a five-year high thanks to better-than-expected Q4 earnings … and that got me thinking about medical device stocks.

Back in March, I picked two stocks to buy[2] in the sector: Sirona Dental Systems (SIRO[3]) and ResMed (RMD[4]). ResMed’s done just fine, up more than 16% since I made the call, but Sirona’s lost about 1%. That’s not horrible, but when you consider that the S&P 500 has gained 8%, it’s not the start I was looking for.

On the sell side, I recommended jettisoning Opko Health (OPK[5]) and Hologic (HOLX[6]). The two have shed 7% and 4% since my call, so I’m pretty pleased.

Now, though, my goal is to narrow thing downs even further, and pick just one stock to buy and one to sell in the medical device industry. While taking into consideration my previous picks, I’m not married to them. If I think there’s a better option going forward — Medtronic’s just one possibility — I won’t hesitate to say so.

Buy

On the buy question, I’m going to stick with ResMed because … well … it has just too many good qualities not to. Take a look at a few:

• It has $672 million in net cash. Of the medical appliance companies with market caps greater than $2 billion, ResMed has the third lowest price-to-cash ratio at 7.1 times, higher than only Stryker (SYK[7]) and Abbott Labs (ABT[8]).
• ResMed’s had 72 consecutive quarters of revenue growth. That’s 18 years without a sales decline. There aren’t too many companies that can boast such a record.
• It’s a leader in the sleep apnea field, a problem whose total cost including less work productivity is $165 billion annually. Using small bolt-on acquisitions, it’s able to improve the technology contained in its key product offerings. With over 18 million American suffering from sleep apnea, it’s a pretty solid market.
• With so much net cash and that fact that it generates more than $300 million annually in free cash flow, it’s likely that the management will significantly increase its 17-cent quarterly dividend, which it paid for the first time in September 2012. If ResMed increased its quarterly dividend to 34 cents, its current yield would jump to 2.7%. In addition, it’s possible it could pay a large one-time special dividend and increase share repurchases. I prefer a lower quarterly dividend with a large discretionary special dividend when the cash situation dictates such a payment.

I was high on ResMed in March and nothing’s happened to change my mind.

Sell

On the sell side of the ball, I’ll go with Boston Scientific (BSX[9]), whose stock is up 62% year-to-date. It seems stent-makers like BSX and MDT are popular with investors these days. Forbes contributor Tom Aspray, who specializes in technical analysis, recently discussed the 15 most overbought S&P 500 stocks[10]. Aspray felt Boston Scientific, the most overbought of the 15, was ready for a multi-week correction.

Technical analysis aside, its interventional cardiology business — the biggest by revenue — delivered a 14% (constant currency) decrease in sales in the first quarter. This unit is responsible for producing drug-eluting stents, catheters, guide wires and other products used for treating cardiovascular disease.

Either we’re getting healthier, which I doubt, or Boston Scientific is losing market share.

Its second biggest segment by revenue is its cardiac rhythm management division, which makes pacemakers and implantable cardioverter defibrillators. Its Q1 revenue was down 4% on a constant currency basis with operating income declining 24%. Making matters worse, BSX was forced to take a $423 million impairment charge on the fair value of the segment’s goodwill.

The only highlight was a 4% increase in revenue for its medical surgical unit, which includes its Precision Spectra spinal cord treatment for chronic back pain. The unit’s operating income was $150 million — 39% of Boston Scientific’s overall operating profit on just 30% of the revenue.

I suppose you could look at this situation as the glass half full: once the other segments get their act together it will be printing money. But I don’t.

Boston Scientific is still in turnaround mode. Its 35% increase in revenue in Brazil, Russia, India and China, while impressive, is not what’s going to solve its problems. It needs to grow its cardiovascular business on both the top and bottom lines.

Until it does that, its 62% gain in 2013 is too much too soon.

Watch

With Medtronic at a five-year high, it would be irresponsible of me to ignore the maker of pacemakers, heart stents, drug pumps and many other medical devices. Medtronic dove below $50 at the beginning of October 2008 and spent the last few years below this bellwether number before going on a big run in the last three months. Prior to 2008 it spent most of its time above $50.

So why the recent change?

Well, Medtronic’s implantable cardioverter defibrillators saw a 2% increase in Q4 revenue — its first gain in years. Spinal revenues in the quarter on a constant currency basis were flat, which is also an improvement over the last several years. And generating $4.4 billion in free cash flow for fiscal 2013, the company’s current free cash flow yield is 8.3%, which is pretty darn good.

I wouldn’t say it’s firing on all cylinders but most of them. It’s got my attention for sure.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2013/05/medical-device-stocks-buy-sell-and-watch/

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