Measuring Medtronic (MDT): Part 2

– Medtronic (MDT) is a large medical technology and equipment company with $14.6 B in revenues last year.  MDT currently 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%: neurological and urological devices);

 ** Diabetes (8%: insulin pumps);

 ** Surgical Technologies (6%: minimally invasive ENT products);

 ** Physio-Control (2%: defibrillators for hospitals and public access).

 – Medtronic was the Online Stock Study for January 2010 at the Better Investing website.  It was led by Avi Horwitz, a Director of the BI Volunteer Board and was different from prior studies in several respects:

** Avi used his completed SSG as the primary reference for polling the study participants, neither MDT’s business nor participant voting was set forth in the study’s Presentation Slides, and (sadly) there was no Consensus SSG.

 ** Questions about the Study may be answered by the recorded session which is not available at this time.  Sooooo, I decided to discuss MDT in more depth (including its quality, competitors, and legal battles) and this post is longer than usual as a result.

Discussion:

– The table below compares Avi’s completed SSG with two of mine and with Take Stock.  Armin-1 was part of “Measuring Medtronic”, a post I did here in September 2009, while Armin-2 is current.  Take Stock is a computerized one-click program at the Stock Central website that is designed to produce a conservative result.

Medtronic          (MDT)	Avi’s SSG	Armin-2           (new)	Armin-1          (old)	Take Stock
Date	12-23-09	1-8-10	9-23-09	1-8-10
Data	S&P	Same	Same	Hemscott-Morningstar
Price	$44.40	$45.99	$32.04	$45.75
52 week High & Low Price	$44.43 & $24.06	$45.81 &          Same	$52.97 & Same	Not Included
Last Q of Reported Data	Q2 ending       10-31-09	Same	Q1 ending      7-31-09	Q2 ending          10-31-09
Software Used	TK5	Same	Same	Online TS
Project Growth From End of	Last FY	Last Q	Same	Last FY
Sales Growth	9.00%	10.00%	Same	7.90%
EPS Growth	8.90%     (from PP)	10.00%	Same	7.90%
High PE	18.0	20.4                  (from 2008)	Same	23.1
High EPS	$4.29	$4.67	$4.56	$4.65
High Price	$77.20	$95.30	$93.00	$107.19
Value Line Estimated High Price = $80-100 as of 11-27-09
Low PE	9.0	8.6                     (from 2008)	Same	17.3
Low EPS	$2.90 (ttm)	Same	$2.83 (ttm)	$3.29
Low Price	$26.10            (low EPS x       low PE)	$24.30               (low EPS x        low PE)	$22.20     (60% x curr price)	$56.82                 (higher than current  price)
Upside/Down	1.8	2.3	3.8	Impossible to Calculate
Total Return	12.8%	11.6%	21.1%	20.2%
SSG Buy Under	N/A	$42.05	N/A	$57.49
RV/PRV	72.5/66.6        (no outliers)	87.8/79.7           (04 & 05 out)	72.4/65.7 (same)	Not Included
RV/PRV                (no outliers)	72.5/66.6	75.4/68.3	N/A	Not Included
Quality	N/A	S&P = A-	S&P = A-	TS = 3.2 unacceptable
PTPM – 5 yr ave	30.00%   trend down	Same	Same	30.50%              trend N/A
ROE – 5 yr ave     Ending Equity	24.70%           trend even	Same	Same	Not Included
ROE – 5 yr ave    Starting  Equity	N/A	26.90%             trend even	Same	28.50%                     trend N/A
Debt to Equity – 5 yr ave	N/A	46.10%             trend up	Same	Not Included

(1) Future Growth Projected From:

– SSG Software allows us to project future growth from the end of the last Fiscal Year, the last Quarter, or the Trend Line.  The Online SSG only projects growth from the end of the last FY.

– Avi’s SSG used the Toolkit 5 software, not the Online SSG, but chose to project growth from the last FY.  Armin-1 and Armin-2, on the other hand, projected from the last Q.

 (2) Estimating Future Sales Growth:

– Avi’s SSG estimated 9.00% Sales growth and offered the study participants five choices to make their estimate: much higher, at least 13.00%; a little higher, 10-12%; 9.00%, seems good; a little lower, 6-8.00%; and no higher than 5.5%.

** Morningstar was estimating 6.00% Sales growth through FY 2014 and Zacks.com 9.57% for the next 5 years, neither of which Avi mentioned.  The Presentation Slides also don’t explain why Avi estimated 9.00%.

[** The recorded session, which became available after I posted this write-up, reveals that Avi’s 9.00% estimate was based on MDT’s recent sales growth (8.00% last FY, 7.5% last Q) plus a little extra to reflect his optimism.] 

(3) Estimating Future EPS Growth:

Consensus SSG & Avi SSG

– Avi used the NAIC/BI Preferred Procedure to estimate future EPS growth and the PP involves four estimates for the next 5 years: Sales Growth [less] Pre-Tax Profit Margin [less] Taxes [divided by] Shares Outstanding [equals] EPS growth. His PP worked out to be 8.90% and that was what he used for his SSG.

– To estimate future EPS growth, Avi offered four choices to the participants: much higher than his estimate, at least 13.00% (the ten-year historical growth rate); a little higher, 10-13.00% (the S&P estimate was $4.76 or 11.00%); 8.90%, Avi’s estimate; and no higher than 8.00%. 

Armin’s SSGs 

– When I did Armin-2, the seven analysts I always check were closely estimating long-term EPS, averaging 10.90% with Zacks.com high at 11.18% and Value Line low at 10.50%.  That’s a very small spread of .68% between the highest and lowest of the seven estimates.

– The 10.90% average was slightly higher than when I did Armin-1 three months earlier.   Armin-1 estimated 10.00% EPS and I decided to use the same for Armin-2.

– For how I estimate EPS for all my SSGs, see Estimating EPS.

(4) Forecasting Future High and Low PEs:

Avi’s SSG

– Avi used 18.0 as his Forecast High PE (down from the historical average of 24.5) and 9.0 as his Forecast Low PE (down from the 11.8 average), and gave the group three choices for their forecast: too high, too low, or just about right.

** The Presentation Slides do not indicate how Avi determined his 18.0 & 9.0.  Slide 54 does show that both High & Low PEs have been trending down each year for the last 5 years with 2008 the lowest at 20.4 & 8.6.

Armin’s SSGs

– Armin-1 and Armin-2 both used 20.4 & 8.6 as the Forecast High & Low PEs, from 2008 and the lowest PEs in the last 5 years.

** When PEs are trending down, I most often use the lowest High and Low PEs in the last 5 years (and when trends are up, I usually begin with TK 5’s Alt-M command, especially when I know nothing about the company).

(5) Final Results:

Avi’s SSG

– His Forecast High Price in the next 5 years (Forecast High PE x High EPS) was $77.20, slightly below the low end of Value Line’s estimated $80-100 High Price.

** I never want to substantially exceed or fall below VL’s estimate, at least not without a very good reason.  For how I determine what’s reasonable for my SSGs, see: Determining What’s Reasonable and What’s Not: An Update.

– Avi got an Upside/Downside Ratio of 1.8 which does not satisfy the minimum SSG Buy criteria of 3.0.  His Total Return was 12.8% which does not satisfy the second, minimum Buy criteria of 15.0%.

[** The recorded session also reveals that the Consensus agreed with each one of Avi’s 5 judgments (Sales and EPS growth, High & Low PEs, and Low Price), perhaps largely because Avi labeled each one as “seems good” or “just about right.”]

[** And, at the very end of the recording, Avi reveals that his SSG was probably “a little too conservative.”]

Armin’s SSGs

– Armin-1 got a 3.8 U/D and a 21.1% TR which do satisfy the SSG Buy criteria.  However, Armin-2, with essentially the same judgments, got a 2.3 U/D and an 11.6% TR which do not satisfy the minimum Buy criteria.

– The reason for this dramatic change is that MDT’s price increased from $32.04 in Armin-1 to $45.99 in Armin-2, up some $13.95 or 43% per share in three months.

Take Stock

– Take Stock got a $107.14 Forecast High Price that was slightly higher than the high end of VL’s estimated High Price of $80-100.

– However, it’s Forecast Low Price was $56.82 and substantially exceeded MDT’s current price of $45.75.  This is a SSG NO-NO according to the BI/NAIC SSG Manual, but this is one of several issues where Take Stock is deliberately designed to be different.

** I think a Low Price that’s not low but high is a serious defect and, when it exceeds the stock’s current price, is especially nutsy!

(6) Quality:

– S&P rated MDT an A- for Quality which is third highest out of its 8 rankings.

– Take Stock gave MDT an unsatisfactory Quality Rating of 3.2 as a minimum of 3.4 is required to pass muster, 6.7 is desired and 10.0 is the max.

(7) Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

PTPM

– MDT’s Pre-Tax Profit Margin is trending down which is usually a red-flag warning sign to consider abandoning the SSG.   Avi did not show this downtrend in the Presentation Slides, but did show it in the Extra Handout Slides.

** Avi did point out the so-called barbed-wire fence (Slide 49) which is not to be crossed if the company’s Quality is questionable. Why he crossed the barbed-wire fence was not explained.

– However, I determined that MDT’s PTPM is way better than its industry average using S&P data (30.0% vs 15.9%, Health Care Equipment industry) and also way better with Hemscott/Morningstar data (30.0% vs 16.2%, Medical Appliances & Equipment industry).  Moreover, MDT ranks 8 out of 118 companies with Hemscott data. 

** Soooooo, I would not cease any analysis just because of MDT’s PTPM trend.

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

 ROE

– No problems are indicated by the ROE trends as they are even and not going down.  Although MDT is better than its industry average with S&P data (24.7% vs 13.3%), it is well below its industry average with Hemscott/Morningstar data (26.2% vs 68.7%).  Here, the problem is the industry average, not MDT.

** The Hemscott/Morningstar industry average is distorted by one company (KCI, 2430% ROE) and when that one company is removed, MDT is much better than the adjusted industry average (26.2% vs 16.2%). 

** Hemscott data at the StockCentral website allows us to easily spot outliers and adjust any industry average because it includes the data for each company in the industry as well as the industry averages.

(8) Competitors:

– According to YahooFinance and Hoovers.com, MDT’s direct competitors are BSX, JNJ and STJ.

– MDT’s latest 10K report lists competitors in each of its seven segments and BSX, JNJ and STJ are mentioned most often:

** BSX and STJ in the CRDM segment; JNJ in spinal; BSX and JNJ in cardiovascular; BSX and STJ in neuromodulation; JNJ in diabetes; and JNJ in surgical technologies.

(9) Legal Problems:

– In October 2007, MDT volintarily stopped the worldwide sale and distribution off its Sprint Fidelis leads which the FDA classified as a Class 1 recall.  Leads are sophisticated wires that directly connect the heart to a defibrillator.  Some Fidelis leads had broken and been involved in unnecessary shocks and at least 16 deaths acknowledged by MDT.

** By August 2009, according to MDT’s latest 10K report, some 1250 lawsuits had been filed against the company including 37 class actions involving 2300 individual personal injury cases.  These suits seek money damages and allege negligence, breach of warranty and other claims.

– In October 2009, after MDT’s 10K had been filed, a Hennepin County (MN) court dismissed 600 of these suits.  Its ruling was based on a 2008 US Supreme Court decision that federal law, the Medical Device Amendments of 1976,  explicitly preempts and essentially prohibits litigation after the FDA has approved a medical device as safe and effective following a full review.

** An article in the New England Journal of Medicine summarized the meaning of this Supreme Court decision: “Patients injured by poorly designed but FDA-approved medical devices now have no recourse.” [emphasis added]

– If you’re interested in learning more about MDT’s other legal problems as well as its business and growth plans, checkout my 10/3/09 post: Measuring Medtronic (MDT)

Armin

*** [I’d appreciate some feedback about this post, especially if you think it’s too long. Other suggestions, of course, are also welcome] *** 

 

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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*** By the way, I’ve added links to my Table of Contents located in the Blog’s “Home” page  in order to make navigation easier.]