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Note to Readers: This report contains substantially new information. Subsequent reports will have changes highlighted.
Reason for Report: 3Q18 Earning Update
Prev. Ed.: Dec 1, 2017; 2Q18 Earning Update (broker materials considered till Nov 30, 2017)
Brokers’ Recommendations: Positive: 66.7% (14 firms); Neutral: 33.3% (7); Negative: 0% (0) Prev. Ed.: 11;8; 0
Brokers’ Target Price: $91(↑$0.8 from the previous report, 19 firms) Brokers’ Avg. Expected Return: 16.2%
*Note: Though dated Mar 2, 2018, share price and broker material are as of Mar 1, 2018
*Note: A Flash update on ‘3Q18 Earnings’ was done on Feb 23, 2018.
Portfolio Manager Executive Summary
Medtronic plc (MDT) is one of the world’s prominent healthcare solutions companies, which provides medical technologies, services and solutions across the globe. The company enjoys a significant position in most of the businesses in which it competes. Medtronic’s operations are widespread with activities in over 160 countries and having more than 85,000 employees. The company was formed through the combination of the legacy Minnesota-based medical technology giant Medtronic, Inc. and Ireland-based Covidien plc, on Jan 26, 2015.
Of the 21 firms covering Medtronic, 66.7% (14 firms) assigned positive ratings and 33.3% (7) provided neutral ratings. No firms issued a negative rating on the stock.
Positive or equivalent outlook (14/21): Per the bullish firms, Medtronic posted encouraging 3Q18 results with earnings beating estimates as well as market expectations. These firms are particularly upbeat about the company’s stellar performance in Pain Therapies, Minimally Invasive Therapies Group, Coronary/Structural Heart and Diabetes businesses. Notably, these businesses surpassed expectations of the bullish firms in 4Q18. The firms also believe that value-based healthcare programs across the Cardiac and Vascular group have contributed to the top line. The bullish firms are also upbeat about Medtronic’s cost-control programs, product launches, improving foreign exchange rates along with benefits from U.S. tax reforms. They believe the company is well-positioned to deliver strong performance based on these factors. Moreover, they are impressed with Medtronic’s strong annual free cash flow balance which will help it cash in on merger and acquisition opportunities.
These firms also believe that the company is adequately utilizing opportunities in the high-potential emerging markets. For FY18, the bullish firms expect growth to come on the back of impressive products such as benefits from intermediate-risk approval in transcatheter aortic valve replacement (TAVR) along with the latest Evolut PRO TAVR, ongoing rollout of Resolute Onyx DES, leadless transcatheter pacing system — Micra — extended destination therapy indication in left ventricular assist device (LVADs) and MiniMed 670G pump in Diabetes with better sensor supply. Moreover, these firms are optimistic about the company’s recently-launched enterprise excellence plan. However, these firms are concerned about the company’s postponement of launch of the robot-assisted surgery platform.
Neutral or equivalent outlook (7/21): For majority of the neutral firms, Medtronic’s 3Q18 earnings and revenue figures were encouraging. However, these firms apprehend that the company will find it difficult to drive margins. Moreover, per these firms diversified business model and recent launches have helped the company counter the headwinds to some extent. However, Medtronic has been facing tough comparisons with competitors’ products, which might impede growth in the days ahead. It is believed these headwinds across Medtronic’s portfolio are going to affect the company’s top-line performance in the rest of FY18. Moreover, these firms are sceptical about Medtronic’s ability to manage costs in order to offset pricing pressure, deal with the MedTech excise tax and attain stable margins. Also, the neutral firms prefer to stay on the sidelines until they get further visibility about the company recovering from lost market share in Cardiac Rhythm Management (CRM) and Spine and increasing market share in other businesses on new product launches.
Mar 2, 2018
Overview
Headquartered in Dublin, Ireland, Medtronic plc (MDT) is one of the world’s leading medical technology companies, aimed at alleviating pain, restoring health, and extending life for millions of people worldwide. The company was formed post the closure of the $50 billion merger between Minnesota-based medical device major Medtronic, Inc. and Ireland-based leading surgical technologies and global healthcare solutions major Covidien plc on Jan 26, 2015.
Medtronic, Inc. and Covidien plc have now become wholly-owned subsidiaries of Medtronic plc, with its principal executive offices based in Ireland. However, the operational headquarters of the combined company remains in Minnesota.
The combined company, with officially joint forces of over 98,000 employees across more than 160 countries and annual revenues of $29.71 billion in 2017, will now expedite the legacy Medtronic's three fundamental strategies of therapy innovation, globalization and economic value. The company’s website is www.medtronic.com.
The combined company’s primary products include those for cardiac rhythm disorders, cardiovascular disease, neurological disorders, spinal conditions and musculoskeletal trauma, urological and digestive disorders, diabetes, and ear, nose, and throat conditions, respiratory monitoring systems, surgical solutions and vascular therapies
The firms identified the following factors for evaluating the investment decision:
Key Positive Arguments / Key Negative ArgumentsMedtronic is one of the leading players in the CRHF segment. A strong pipeline and the potential launch of many products in the future should strengthen it further. / Medtronic faces increasing competition from Stryker and Boston Scientific in the spinal and CRHF markets respectively.
On completion of the Covidien acquisition, Medtronic has emerged as the world's premier medical technology and services company. / The firms are also concerned as the company’s core businesses are struggling with pricing pressure.
Medtronic rewards its shareholders in the form of regular dividends and share repurchases. Moreover, the company has lately raised its cash dividend by 7%. / Medtronic earned 46.9% of total revenues in 3Q18 from international operations, which makes it highly exposed to the risk of fluctuation in foreign exchange.
Note: Medtronic’s fiscal year ends on Apr 30.
Mar 2, 2018
Long-Term Growth
The firms believe that despite a tough competitive scenario, Medtronic has the advantage of enormous resources, incremental sales synergies and multiple options within the medical devices industry. The company holds a significant market share in the cardiology and spine markets, as well as targeting other specialty markets. With the acquisition of Covidien, management of the combined company currently aims at driving strategies, diversifying the company’s growth profile and increasing its financial flexibility over the long term.
Post the Covidien acquisition, management is focused on delivering state-of-the-art healthcare innovation, addressing the inequity in healthcare access globally, and emerging as a leader in the changing value-based healthcare landscape. Notably, in 3Q18, Medtronic successfully completed the $850-million Covidien synergy commitment.
Medtronic also launched its Enterprise Excellence Program at the J.P. Morgan Healthcare Conference held in January 2018. Management expects to generate $3 billion in annual growth savings by the end of fiscal 2022 from the restructuring initiatives listed under the program. Notably, Medtronic aims at enhancing margins and increasing investments on strategic growth initiatives through this program. Per management, this program to maintain efficiency and accelerate long-term business growth has a three-fold strategy —
Global Operations – targeting integration of manufacturing and supply systems and enhancing delivery, cost, quality and cash flow over the period.
Functional Optimization – focusing on enhancing productivity and employee experience by leveraging and improvising on global operating models and systems.
Commercial Optimization – aiming to enhance the productivity and customer experience by optimizing certain processes, systems and models.
Interestingly, the program will be managed by a central Program Management Office. Moreover, per management, the program will result in incremental restructuring expenses of around $1.6 billion to $1.8 billion over the next five years. However, half of the charges are projected to fall under the employee-related costs category.
Mar 2, 2018
Target Price/Valuation
Rating DistributionPositive / 66.7%↑
Neutral / 33.3%↓
Negative / 0.00%
Avg. Target Price / $91↑
Digest High / $99.00↑
Digest Low / $80.00
No. of Analysts with Target price/Total / 19/21
Upside from Current / 16.2%
Maximum Upside from Current / 26.4%
Minimum Upside from Current / 2.2%
Risk factors to the target price comprise a competitive scenario, economic and legal issues, and foreign currency movement.
Recent Events
On Feb 20, 2018, Medtronic reported 3Q18 results. Highlights are as follows:
Ø Adjusted EPS in 3Q18 came in at $1.17, up 4.5% year over year (y/y).
Ø In 3Q18, revenues totaled $7.37 billion, up 1.2% y/y and up 7% at constant exchange rate (CER).
Ø For FY18, the company maintains revenue growth expectations in the range of 4-5% and adjusted EPS growth in the band of 9-10% at CER.
Other Events
On Feb 26, 2018, Medtronic announced the receipt of expanded FDA approval for the Guardian Sensor 3. Per management, the receipt of the expanded approval will allow users to wear the sensor on the upper arm. This will lead to enhanced efficiency, accuracy and flexibility.
On Feb 26, 2018, Medtronic announced FDA nod and U.S. launch of the Resolute Onyx 2.0 mm Drug-Eluting Stent (DES). The new stent is the smallest in size in the market presently. The Resolute Onyx DES is available for use in all sizes in the United States, Europe and in countries that recognize the CE Mark.
On Feb 21, 2018, Medtronic broadened the MiniMed portfolio with the introduction of MiniMed Mio Advance infusion set. This latest offering from the company’s Diabetes business will be made commercially available in Canada, Hong Kong and certain countries in Europe in fourth-quarter fiscal 2018. However, the company plans an expanded launch of the same in 2018.
On Feb 15, 2018, Medtronic presented positive data from an at-home pediatric study on patients aged between seven and 13 years. Notably, the data is based on MiniMed 670G system and was demonstrated at the Advanced Technologies & Treatments for Diabetes’ 11thInternational Conference in Vienna, Austria.
Revenues
Total revenues were $7.37 billion in 3Q18, up 1.2% y/y (up 7% at CER). Foreign currency fluctuation favorably impacted revenues in 3Q18 by $177 million.
Management believes that segmental and regional growth in all lines as well as strong operating performance, largely based on the company’s synergy programs from the Covidien integration, drove revenues in 3Q18.
Geographic Scenario
Post the Covidien acquisition, Medtronic currently reports in three geographic regions: United States, Non-U.S. Developed, and Emerging Markets. Medtronic includes Puerto Rico in the U.S. line (consistent with legacy Medtronic), whereas legacy Covidien used to consider Puerto Rico in its Non-U.S. Developed line. Medtronic includes Israel, Greece and Korea in the Non-U.S. Developed line (consistent with legacy Medtronic), while legacy Covidien included these countries in its Emerging Markets line. Medtronic’s definition of Emerging Markets is consistent with how the legacy Medtronic defined its Emerging Markets division.
Medtronic raked in 53.1% of total revenues from the domestic market in 3Q18, down 4.9% y/y to $3.91 billion. In the non-U.S. developed markets, the company garnered $2.36 billion, reflecting an improvement of 7.8% y/y (up 5% at CER). This region represented 32% of the company’s total revenues in 3Q18.
Revenues from emerging markets recorded 11.8% y/y (up 12% at CER) growth to $1.10 billion, representing 14.9% of Medtronic’s total revenues in 3Q18. Moreover, the growth in emerging markets was in line with management’s long-term growth expectations.
Globally, Medtronic continues to expand access to its products and services. In addition to ongoing traditional market development, management has plans of structuring partnerships with both governments and the private sector, as well as optimizing its channels. The company believes that these initiatives will not only lead to long-term leadership in emerging markets but will also make way for sustained market outperformance.
The company witnessed double-digit growth in Southeast Asia, Eastern Europe, Latin America, and the Middle East and Africa and China.
Outlook: For FY18, Medtronic continues to expect revenue growth of 4-5% at CER. However, the company revised its foreign currency fluctuation estimation, which is now projected to have a positive $480-$500 million impact on fiscal results compared with $275-$375 million estimated earlier. Moreover, for 4Q18, Medtronic expects currency translation to have a favorable impact of $300-$320 million on revenues.
Per the bullish firms, based on strength in CRM, Spine, Diabetes and Neuromodulation businesses, Medtronic is well-positioned to deliver encouraging top-line performance.
Segments
According to Medtronic, the combined business has been divided into four major groups – Cardiac and Vascular Group (CVG), Minimally Invasive Therapies Group (MITG) (formerly referred to as the Covidien Group following completion of the Covidien acquisition), Restorative Therapies Group (RTG) and the Diabetes Group.
Further, the Peripheral Stents, Directional Atherectomy and Chronic Venous Insufficiency (CVI) businesses of the former Peripheral Vascular business of Covidien have been combined with CVG's Aortic and Peripheral Vascular business. The remaining businesses of the Peripheral Vascular division, namely Compression, Dialysis and Other Peripheral product lines, have moved to MITG’s Surgical Solutions group. The Covidien’s Neurovascular business has been integrated into RTG as an independent business unit.
1. Cardiac & Vascular Group (CVG)
The Cardiac and Vascular Group (CVG) includes the Cardiac Rhythm & Heart Failure, Coronary & Structural Heart, and Aortic & Peripheral Vascular divisions.
Revenues at the CRHF division increased 6% y/y (up 4% on a CER basis) to $1.46 billion in 3Q18. Per management, growth in this division was driven by Arrhythmia Management, led by high-teens growth in atrial fibrillation Solutions at CER, amplified penetration of the Micra transcatheter pacing system, and strong uptake of the TYRX absorbable antibacterial envelope. This apart, strong demand for the company's suite of quadripolar cardiac resynchronization therapy-pacemakers (CRT-P) along with growth in Mechanical Circulatory Support drove Heart Failure division revenues.
On Nov 20, Medtronic announced the receipt of FDA approval and commercial launch of its portfolio of Azure pacemakers with BlueSync technology. According to the company, this technology enables secure, automatic and wireless remote monitoring via the Medtronic CareLink Network. Security controls implemented and validated on BlueSync-enabled devices include access restrictions to protect integrity of device functionality and end-to-end encryption to protect patient data.