Measuring Medtronic (MDT)

[AF addendum:  Jay P’s SSG and First Cut write-up of Medtronic, discussed below, are also summarized in the December 2009 issue of Better Investing magazine]

– Medtronic is the world’s largest medical technology company with FY 2009 revenues of $14,599 B, up a satisfying 8%.  MDT operates in seven segments: Cardiac Rhythm Disease Management (34% of FY 09 revenues: pace-makers and implantable defibrillators); Spinal (23%: artificial spinal discs); Cardiovascular (17%: heart valves, stents); Neuromodulation, (10%: implantable stimulation devices); Diabetes (8%: insulin pumps), Surgical Technologies (6%); and Physio-Control (2%: defibrillators for hospitals and public access).

 Company Background:

– MDT is a global company that manufactures and sells its devices in more than 120 countries. Its 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.

– Morningstar reports that Medtronic has successfully expanded its business away from MDT’s traditional reliance on heart disease and is now developing products for a wide variety of chronic diseases.   Revenues from investments in neuromodulation, diabetes, and spinal products have increased from 25% of total sales in FY 2000 to 41% in FY 2009.

– Significant future growth is expected in three areas: MDT’s spinal bone graft product, one-of-a-kind in its market, and from atrial fibrillation and transcatheter heart valves.

– The one-click Annual Report spreadsheet by Bob Adams gives MDT’s 2009 A.R. a 55 out of 100 with 16 green flags, 2 red flags, 10 Bullish results and 8 Bearish results. 

** The Bullish-good things include increasing sales that are also increasing faster than related costs; growing gross profit margin; good free cash flow.  The Bearish-not so goods include increasing inventories and shares outstanding; and high debt to equity which is also one of the red flags.

** You can get this super-duper spreadsheet and an explanation of its many features by going to my Favorite Links page and scrolling down: click here.

– Legal matters:

** MDT just paid $442 M to settle a long-standing patent lawsuit involving drug coated stents that substantially reduced its 1Q earnings;

** The FDA, in July 2008, issued a warning letter to doctors regarding MDT’s Infuse Bone Graft product and reports of life-threatening complications from unapproved use;

** MDT’s latest Annual Report mentions that it incurred four litigation charges in 2009 totaling $714 M, all of which involved patent or royalty disputes.

** MDT’s A.R. also mentions that some 1250 personal injury lawsuits are pending, including 37 class actions, involving the company’s Sprint Fidelis defibrillator leads which it recalled in 2007.  Wikipedia explained these leads sometimes malfunctioned and were implicated in several deaths.

Discussion:

– The following table compares the SSG by JayP, which I got from Better Investing’s First Cut page, with two of mine and with Take Stock.  Armin-1 uses S&P data from the Better Investing while Armin-2 uses the same judgments, but with Hemscott-Morningstar data from Stock Central.

Medtronic (MDT)	JayP	Armin-1	Armin-2	Take Stock
Date	9-21-09	9-23-09	Same	Same
Data	S&P	S&P	Hemscott-Morningstar	Same
Price	$37.48	$37.04	Same	$37.35
52 week High & Low Price	$54.02 &          $24.86	$52.97 &            Same	Same	Not                       Included
Last Q of Reported Data	Q1 ending           7-31-09	Same	Same	Same
Software Used	TK 5	Same	Same	TS Online
Project Growth From End of	Last Q	Same	Same	Last FY
Sales Growth	08.00%	10.00%	Same	07.90%
EPS Growth	09.00%	10.00%	Same	07.90%
High PE	21.8                    (last 3 yr ave)	20.4                  (2008)	17.8                   (2008)	23.1
High EPS	$4.31	$4.56	$5.12	$4.65
High Price	$94.00	$93.00	$91.10	$107.19
Value Line Estimated High Price = $80-100 as of 8-24-09
Low PE	14.4                     (last 3 yr ave)	08.6                (2008)	07.7                  (2008)	17.3
Low EPS	$2.80                (last FY)	$2.83                  (TTM)	$3.22                 (TTM)	$3.22
Low Price	$24.10              (recent severe low)	$22.20                (60% x              current price)	Same	$55.71                 (higher than current price)
Upside/Down	4.2	3.8	3.6	impossible to calculate
Total Return	21.1%	21.1%	20.8%	25.5%
SSG Buy Under	N/A	$39.92	$39.43	$58.51
RV/PRV	72.9/67.1         (2004 &             2005 out)	72.4/65.7        (Same)	56.7/51.5	Not                      Included
Quality	N/A	A-	Not Included	3.2 (unacceptable)
PTPM – 5 yr ave	30.0%                Trend down	Same                 Same	30.5                  Same	Same                Trend N/I
ROE – 5 yr ave   End Equity	24.7%                Trend even	Same                Same	26.2%              Trend up	Not                 Included
ROE – 5 yr ave  Start Equity	N/A	26.9%               Trend even	28.5%                 Trend up	Same                 Trend N/I
Debt to Equity –  5 yr ave	N/A	46.1%              Trend up	45.2%              Trend up	Not                     Included

Estimating EPS:

– Jay estimated 9.00% EPS and his First Cut write-up says that it was “in line” with Value Line and with 25 analysts who follow MDT.

** VL was actually estimating 10.00% and the 25 analysts were not identified nor were there estimates revealed.  The MDT website lists 18 analysts who follow the company, but no estimates are set forth.

– When I did my SSG on 9-23-09, the six analysts I always check were closely estimating long-term EPS at an average of 10.43% with FactSet CallStreet via CNNMoney.com high at 11.00% and Value Line low at 10.00%.  Thomson-Reuters via YahooFinance.com was 10.23%, Zacks.com was 10.31%, S&P was 10.40%, and Reuters.com was 10.62%.

** I had SSGed MDT on 8-24 and only FactSet and Value Line remained the same.  The average then was 11.04% with S&P the largest reduction from 13.40 to 10.40% and the others going down only slightly.

 ** I continued to estimate 10.00% EPS which was the lowest estimate of the six by VL.

 Forecast High PE:

– Jay eliminated 2004 & 2005 as outliers and used the resulting three-year average of 21.8 as his Forecast High PE.

– I also eliminated those two outliers, but saw that the trend was downward so I used 2008 (20.4, the lowest in the last 5 years) as my Forecast High PE.

– Take Stock is not programmed to look for trends and always eliminates the five highest High PEs in the last 10 years and uses the resulting average (23.1) as its Forecast High PE.  This is equivalent to the Alt-M command in TK 5 and TK 6.

 Forecast High Price:

– Take Stock at $107.19 was the only analysis to exceed Value Line’s estimated High Price of $80-100. 

– I never want to substantially exceed VL and Take Stock’s 7% excess doesn’t seem unreasonably high to me.  For how I determine if SSG judgments are reasonable, see: Determining What’s Reasonable and What’s Not: An Update

Forecast Low Price:

– Jay used MDT’s recent severe low price of $24.10 while I used $22.20, 60% of MDT’s current price. 

– Take Stock, on the other hand, got a much, much higher Forecast Low Price of $55.71 which substantially exceeded MDT’s current price of $37.35.

** While this is a SSG NO-NO according to the BI/NAIC SSG Manual, this is one of several issues where Take Stock is deliberately designed to be different.

** I think it’s absurd to have a Low Price that’s high, especially when it exceeds the stock’s current price, and constitutes a serious defect in my judgment. 

Pre-Tax Profit Margin:

– MDT’s Pre-Tax Profit Margin is trending down, which Jay did not mention, and which is usually a red-flag warning sign to consider abandoning the SSG.

– However, using S&P data, MDT is way better than its industry average (30.0% vs 16.4%, Health Care Equipment industry) and also way better with Hemscott data (30.5% vs 16.6%, Medical Appliances & Equipment industry).  Moreover, MDT ranks 8 out of 118 companies with Hemscott data.  Soooooo, I would not cease any analysis because of MDT’s PTPM trend.

– To learn more about using Industry Info, see: Investigating Industry Info

Quality:

– S&P gave MDT an A- for quality (which doesn’t show on Jay’s PDF copy) while Hemscott has no quality rating.  S&P uses an eight-point scale with A+ the highest score.

– Take Stock rated MDT a 3.2 which is unacceptable as 3.4 is the minimum required to pass muster and 6.7 is desired.

Final Results:

– Jay and my two SSGs are very close: all got a Total Return of around 21% as well as an Upside/Downside Ratio of between 3.6 and 4.2.  A TR > 15% and a U/D >3.0  means that MDT is a SSG Buy.

– Take Stock’s Forecast Low Price exceeded MDT’s current price which meant that it was impossible to calculate and compare our U/Ds.  Take Stock also gave MDT an unacceptable quality rating while S&P gave it an A-.

Final Thoughts: [Addendum]

– While the SSG does not ask about legal issues, they can influence whether we make optimistic or pessimistic judgments, and also whether we Buy, Hold or even Sell the stock.

– Medtronic and other medical equipment makers (like Stryker and Zimmer) are in a risky business: bad news about patient injuries, governmental investigations, and/or new class actions can cause the stock price to plummet.

– Armin

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