As expected, Medtronic [MDT: NYSE] reported in-line Q3 results on the strength of its core Cardiac Rhythm Management (CRM) segment. What’s surprising, however, is the sharp decline in the medical equipment maker’s vascular business. We had foreseen eroding stent sales, but Q3’s drop-off was more severe than expected. As of now, Medtronic’s diversified business is strong enough to offset those losses, and the firm has expressed comfort in meeting consensus 2002 earnings projections. The company’s rich pipeline of products also strengthens its ability to offset any losses. A Buy rating is reiterated, particularly in light of recent weakness in the stock.
For the quarter, Medtronic posted EPS of $0.30, which matched expectations. Sales, however, came in at $1.592bn, below the estimated $1.62bn. Unfavorable foreign exchange rates, especially that of the yen, shaved $14.5m off the top line, while the firm’s weaker-than-expected vascular business also contributed to the shortfall.
Sales in the vascular business, which includes coronary stents, dropped 17% quarter-over-quarter to $189.8m. The sharp decline comes on the continued fallout from an unfavorable patent ruling. In Q2, a court ordered Medtronic to cease US sales of a popular stent delivery system, which was found to have infringed on rival Boston Scientific’s [BSX: NYSE] patents. Despite the disappointment, Medtronic says it is committed to the division, and anticipates a slight rebound in Q4.
The long-term prospects of Medtronic's vascular business are brighter, as the segment is expected to grow significantly with the help of Medtronic's drug-coated stent. The company noted in its conference call that it will begin human testing of the stents this summer, which should allow the firm to launch its drug-coated stent between 2H:03 and 1H:04. This places the firm behind Johnson & Johnson [JNJ: NYSE], by about 9-15 months, and Guidant [GDT: NYSE], by about 6-9 months (assuming a J&J launch no earlier than early 2003). Still, Medtronic maintains that the drug it is using to cover its stents will prove more effective than that of its rivals.
Sales in the company’s core CRM segment jumped 15% to $732m. Sales in 2002 could be further augmented by the launch of new products, such as its Carelink programmer, in Q4. Medtronic also announced that it has separated its Neuro/Spinal/Diabetes/ENT group into two separate segments: Neurological & Diabetes and Spinal/ENT/SNT. For the quarter, Neurological & Diabetes grew 80%, thanks to the key acquisition of diabetes product maker MiniMed. The Spinal/ENT/SNT unit also grew 24%.
During its conference call, management said it is comfortable with consensus Q4 and full-year estimates. Currently, the Street is expecting Q4 EPS of $0.34, and 2002 EPS of $1.21. Management also projected another quarter of broad-based growth. To meet its goals, the firm will rely on its more profitable divisions to shoulder losses – the CRM segment will help.
The medical equipment maker’s robust pipeline should also fuel 2002 growth. On Tuesday, the firm launched its next-generation Paradigm insulin infusion pump. The product is expected to increase MiniMed’s dominance of the diabetes market. Medtronic also has high hopes for its InSync ICD self-regulating pacemaker, which is scheduled to be reviewed by a Food and Drug Administration (FDA) panel on March 5. Once approved, InSync ICD is expected to drive growth in the firm’s CRM business.
Valuation-wise, shares are currently trading at 33x fiscal 2003 earnings estimates, which is more expensive than Guidant, currently trading at 21x its expected 2003 earnings, and Boston Scientific at 20x. Medtronic, however, has the most potential for growth. We do not believe that current estimates take into consideration the firm’s line of new products, which could provide an unexpected upside in earnings in 2003.
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