Medtronic Q1 Earnings Preview: Growth Momentum Picking Up

Medtronic (NYSE:MDT) is set to announce its Q1 fiscal 2014 earnings on August 20, where we expect it to post mid-single digit growth. Its key pacemakers & defibrillators business, which was a major drag on revenue growth for the last two years, seems to be getting back on track. Further, revenues will be supported by the continued growth in cardiovascular, diabetes and surgical technologies businesses. Spinal franchises, however, will continue to register a drop in revenues. For the quarter, we expect gross margins to weaken slightly mainly due to pricing pressure in some businesses and foreign exchange fluctuations. However, Medtronic’s cost-cutting efforts, which include several rounds of job cuts, should lend support to overall operating profit margins.

Last quarter, Medtronic reported 4% growth in revenues to $4.5 billion. For 2014, the company has provided revenue growth guidance in the range of 3% to 4%. Below we take a look at the important trends that could impact the company’s performance during the quarter.

See our complete analysis of Medtronic here

Growth Across The Board

As witnessed in Boston Scientific’s earnings, procedural volumes and corresponding demand for implantable cardioverter defibrillators (ICDs) continued to remain dull in the U.S. (Read Boston Scientific Surprises With Revenue Growth And New Products). Hospitals continue to manage their inventories very tightly and their bulk purchases may have declined on a year-over-year basis. However, we don’t expect it to weigh on the pacemakers & defibrillators division as, in the last quarter, the company was able to keep its procedure volumes stable despite similar weakness. Procedural volumes growth in international markets like China will add to revenue growth. Pricing improvements will also lend support. Pacemaker sales should also register mid-single digit growth. While the pacemaker demand in the U.S. remains a little weak, the international markets will more than offset the pressure. The Advisa pacemaker, a second generation MRI-safe pacemaker, continues to see strong sales in Japan.

We expect revenues from the cardiovascular segment to continue to grow despite weakness in the U.S. and European stent markets. New products like Resolute Integrity drug eluting stent (DES) have been doing well in the international markets. The renal denervation device (a radiotherapy-based system to treat high blood pressure), Symplicity, should also register modest growth. However, we have our eyes on the updates related to the progress of the upgraded version as competition is getting intense with many players including Boston Scientific entering the market. (Read our note  Boston Scientific Acquires Vessix Vascular To Bolster Peripheral Intervention Business for further details).

In the structural heart part of the cardiovascular franchise, transcatheter valves will continue to be the major growth driver with mid-teens growth. Surgical technologies will get a boost from the continued adoption of products for navigated spine procedures. We also expect moderate growth in the diabetes franchise as growing competition will partially offset strong sales of its innovative insulin pumps.

The only business that is expected to weigh on revenue growth is the spinal division. The key product of this division, a bone graft paste called Infuse, continues to see a decline in use in spinal surgery following efficacy concerns. The company was hoping to address these concerns with the outcome of an independent review from Yale University. However, the outcome, which became public in June, has not come in favor of the company. It suggested that Infuse doesn’t show significant benefits over conventional spine surgery and may even lead to serious side-effects including cancer and sterility in men (Read Medtronic: Independent Review Raises Doubts On Benefits Of Infuse Bone Graft). The Infuse bone graft still constitutes a significant portion of overall revenues from the division even as its annual sales dropped from around $900 million in 2011 to nearly $500 million in 2012. The continued adoption of Solera and the Atlantis Vision Elite cervical plates, however, will continue to lend some support.

Operating Margins Should Improve

We expect gross margins to remain under pressure due to stiff competition and pricing pressure in developed markets. While the launch of new products will lend support to some extent, a stronger U.S. dollar will also adversely impact gross margins. However, with various cost cutting measures including job cuts in place, we expect R&D and SG&A expenditures as a percentage of revenues to decline. The medical device maker is axing 2,000 more jobs worldwide as part of its plan to cut as much as $1.2 billion in costs over the next few years. This should lead to some improvement in its overall operating profit margins.

We currently have a $56 price estimate for Medtronic, which is in line with the current market price.

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