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Biotech / Medical : Medtronic (MDT) -- Ignore unavailable to you. Want to Upgrade?

To: Jack Hartmann who wrote (579)	8/23/2002 4:36:46 PM
From: Jack Hartmann	Respond to of 687

Morningstar on MDT Analyst Report \| 08-21-2002 by Jill Kiersky Update Medtronic's July-quarter results showed strong sales and earnings growth, but we question whether the company can sustain this level of performance. Revenue from cardiac rhythm management devices was up 18% from the year-ago quarter, thanks to new product introductions like the InSync ICD, the only approved therapy for both sides of the heart. This increase in revenue far exceeded the decline in the vascular business, which saw sales fall 28% year over year. Overall, revenue increased nearly 18% while net earnings improved 14%, despite higher spending on sales, research, and development. But Medtronic is losing the race to bring drug-coated stents to market, which could exacerbate the weakness in the vascular business. And competition for the newer heart systems isn't too far behind. New products in development for spinal surgery and diabetes could help moderate sales growth, which we still believe will average 13% over the next five years. Given the challenges with drug-coated stents and increased spending, we'd only be willing to buy the shares at a discount to our fair value estimate. Thesis Medtronic may be the largest medical device maker and the leader in many of its product lines, but it will have to work hard to sustain its performance. We'd like to see a modest discount to our fair value estimate before adding shares. A handful of companies dominate the medical device industry. Despite regulatory pressures that attempt to drive prices lower, firms have achieved economies of scale that provide decent margins and keep new competition at bay. Medtronic and its competitors defend their share primarily through product innovation and heavy-duty sales and marketing. Medtronic's performance in both areas has paid off. The company makes better use of its research and development dollars; over the past three years, it spent an average 10% of sales on R&D while increasing sales an average 16%; in comparison, rival Guidant GDT spent 14% on R&D to gain 13% in sales over the same period. Medtronic is the clear cardiovascular device leader, with $6.4 billion in annual sales and more than 50% of the market for cardiac rhythm management devices like pacemakers and defibrillators. The company manages to turn about 20% of sales into free cash flow (cash from operations minus capital expenditures)--more to spend on development. While Medtronic's grasp on cardiac rhythm management remains strong, the firm is losing ground in the vascular market. It lost about 15 percentage points ($200 million in sales) of its market share in perfusion delivery systems after dropping its license with Boston Scientific BSX. Our bigger concern is its third-place position in the drug-coated stent race. Drug-coated stents, which effectively eliminate the reblocking of blood vessels, could cannibalize the market for bare-metal stents (which keep the blood flowing but often close up). Their entry could expand the total worldwide stent market to more than $4 billion by 2005, from $2.2 billion today. Medtronic is developing a drug-coated product with Abbott ABT, but we expect Johnson & Johnson JNJ, Boston Scientific, and possibly Guidant to have their versions on the market by the time Medtronic's is approved. As drug-coated stents are made available, we expect bare-metal stent prices to decline significantly, leaving Medtronic, which now sells about 15% of all bare-metal stents, in the lurch. Given the challenges in the stent market and the constant need to enhance cardiac products, we'd want a 20% margin of safety to our fair value estimate before buying the shares. Valuation Considering the challenges in delivering drug-coated stents, we're not giving Medtronic much credit for any share it may gain if it develops a successful product. We believe the company's superior position in heart devices, insulin pumps, and new devices for Parkinson's disease and spinal surgery will lead to compound annual growth of 13% through 2006--shy of the company's 15% forecast. We also model operating margins gradually rising to 35%, up slightly from current margins. The stock has dropped to more-reasonable levels since the beginning of 2002, but we think it is only fairly valued near $40. We would like a bigger discount to make room for the challenges Medtronic faces. Jack