A Health Care Stock Set to Prosper In Emerging Markets
Foolish investors would do well to take a close look at medical device company Covidien . The company is often ignored by investors in the medical device sector. It doesn't have the glamour appeal of a peer like say, Intuitive Surgical and its surgical robotic systems. It doesn't offer the familiarity and solidity of having a medical device division within a major company like Johnson & Johnson . Moreover, its forecast EPS growth rate of 7.5% in 2013 is hardly the stuff of legend. So what is there to like about the stock?
Why Covidien's offers more than its peers
Covidien's key attraction is its mix of relatively low-ticket medical device solutions with which it can penetrate emerging markets. This is a major benefit as hospitals and clinics in the developed world are being challenged by austerity measures. A lot of Covidien's products simply fall below the radar of targeted cutbacks. Meanwhile, austerity is hitting the industry hard. For example, Johnson & Johnson only managed to report revenue growth of 0.3% in its medical devices and diagnostics segment, in its last quarter. Its international revenue grew 4.2% with the segment, but US revenue declined by a similar amount.
Meanwhile, Intuitive Surgical's challenge is to convince hospitals and clinics of the merits of its high-ticket robotics solutions. This not an easy task at the best of times, and it's a lot harder when a study like this one from the Journal of the American Medical Association comes out, which claims "Total costs associated with robotically assisted hysterectomy were $2189 (95% CI, $2030-$2349) more per case than for laparoscopic hysterectomy." Note that Covidien is one of the leading players in laparoscopic instrumentation.
Intuitive has had a difficult year, and it only managed to sell 101 systems in its last quarter, compared to 155 last year. Only 36 systems were sold internationally, of which only six went outside Europe or Japan. It's not looking like an emerging market play!
Covidien's confusing quarter
While Covidien is thematically attractive, its recent fourth-quarter results were not superficially impressive. Adjusted diluted EPS growth was just 5.8% on the quarter, and non-GAAP adjusted operating margins fell 110 basis points. However, you should look beyond these numbers, because the underlying performance is much better. On its conference call, the management outlined:
We delivered adjusted EPS of $0.91 for the quarter, a 6% increase over the prior year, despite the impact of unfavorable FX and the medical device tax. Combined, these 2 items reduced EPS by about $0.10 per share or 11 percentage points
Adding the $0.10 back in EPS gives a far more impressive growth rate of over 17% on the quarter. And on the issue of operating margins:
we declined 110 basis points year-over-year on operating margin. 170 basis points was due to FX and device tax. So we actually would have improved operating margin 60 basis points
The results were a lot better than they appeared.
Emerging markets and supply issues
All told, there were some positive and negative points in the quarter. Its emerging market revenues continue to grow strongly with revenue from the BRIC countries increasing 25%. According to Covidien, emerging markets now make up around 16%-17% of total revenues, and at these kinds of growth rates they are likely to hit 20% of sales by the end of 2014.
On a less positive note, its medical supplies business (around 17% of full-year sales) had a disappointing quarter with US sales down 2%, amid suffering some cost increases due to issues with a supplier. According to the company, the latter issue has been fixed, and it also expects medical supplies volumes to get back into a normal range in upcoming quarters. Its something to look out for going forward.
Where next for Covidien?
Analysts have Covidien on 7.5% EPS growth for 2014, and this is despite facing a headwind from the medical device tax in the first, and ongoing difficult foreign exchange comparisons in the first half. The underlying business is solid, and on a P/E ratio of around 16 times forward earnings the stock is good value for its emerging market growth prospects.
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The article A Health Care Stock Set to Prosper In Emerging Markets originally appeared on Fool.com.Lee Samaha owns shares of Covidien. The Motley Fool recommends Covidien, Intuitive Surgical, and Johnson & Johnson. The Motley Fool owns shares of Intuitive Surgical and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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