Heart Devices Drive Medtronic’s Robust Earnings

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Medtronic (NYSE: MDT) reported better-than-expected fiscal third quarter results on Tuesday, February 17, with operational revenue growing 7.5% year-over-year (y-o-y) to about $4.32 billion, driven by balanced growth across business divisions and geographies. The company’s largest division, Cardiac Rhythm Disease Management (CRDM), grew in double digits, driven by sales growth of about 50% in Atrial Fibrillation and 17% in the Pacemaker business. Other businesses such as Neuromodulation, Surgical Technologies and Diabetes also registered robust revenue growth. International sales accounted for 43% of total revenues for the medical device maker, driven by 12% y-o-y growth in emerging markets, which represent about 13% of company-wide sales. [1] ((Press release, Medtronic, Feb 17 2015))

The company’s gross margin was up sequentially on an operational basis at 74.1%, on the back of declining production costs in the Diabetes business, which partially offset expenses related to addressing product quality issues in Neuromodulation and the product mix shift towards Atrial Fibrillation and diagnostic products. Going forward, the company expects gross margins to come down to 69-71% on a constant currency basis on account of Covidien’s lower gross margins. Covidien reported overall gross margins of about 61% for its first fiscal quarter ending December 2014.

Medtronic completed the $43 billion acquisition of Ireland-based Covidien last month, after receiving all relevant approval. The combined Medtronic-Covidien entity, with a presence in more than 150 countries, is expected to drive more value and improve operational efficiency by offering various healthcare and diagnostic products and services as a package to its customers. Covidien generated about $10.7 billion in revenue in calendar year 2014 compared to Medtronic’s $17.5 billion, with over 50% of sales coming from outside the U.S.

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Our price estimate for Medtronic’s stock is currently around $61, which is significantly below the market price. We are in the process of updating our model in light of the recent earnings and the acquisition of Covidien.

See our full analysis for Medtronic Inc.

Double-Digit CRDM Sales Growth Drives Company’s Top Line

Cardiac Rhythm Disease Management, primarily consisting of defibrillators and pacemakers, is Medtronic’s largest division, accounting for over 30% of total sales. During Q3 FY 2015, operational sales in the division grew by 12% y-o-y to $1.27 billion on account of solid domestic sales growth in Pacemakers (reported as Low Power) and Atrial Fibrillation, and strong international performance of the implantable cardioverter defibrillator (ICD, reported as High Power) business.

Medtronic reported a return to positive sales growth in the U.S. ICD market last quarter after several quarters of consistent declines. The company’s overall ICD sales grew by 4% y-o-y driven by growing adoption of its Viva XT CRT-D with its Attain Performa quadripolar (APQ) lead. Following the growing acceptance of its APQ lead in Japan in early 2014, the company launched the product in the U.S. in September. Management reiterated on its earnings call that the response to the product continued to be impressive. Meanwhile, sustained global demand for the Reveal LINQ system contributed to the 17% sales growth in the Low Power division in the quarter.

In the Atrial Fibrillation division, sales grew about 50% on a constant currency basis on account of solid demand for the Arctic Front CryoAblation System. Going forward, we expect sluggish U.S. sales to offset international market gains in the overall Cardiac Rhythm Disease Management business. Medtronic stated that its share in the domestic CRDM market had started showing signs of improvement on the back of its recent launches such the Viva CRT-D and APQ lead.

CoreValve Continues Strong Run In The U.S. TAVR Market

The Cardiovascular division, consisting of the Coronary, Structural Heart and Endovascular businesses, offers products such as stents, heart valves and renal denervation systems for treating hypertension. The Cardiovascular division, contributing over 20% of Medtronic’s sales, grew by a modest 2% y-o-y, registering sales of $955 million in the fiscal third quarter. Sales of drug eluting stents (DES) were slightly down in Q3, likely in anticipation of the company’s new product, Resolute Onyx DES, which was launched in November 2014. Sales should improve going forward as the new product gains adoption.

The Structural Heart business reported 22% sales growth, as the CoreValve Transcatheter Aortic Valve (TAVR) system continued its strong performance in the U.S. The company is aggressively expanding its presence in the U.S. TAVR market following its settlement with Edwards regarding a patent infringement issue last year. Medtronic expects the global TAVR market to grow at 20-25% in 2015.

Consistent Sales Growth In Surgical Technologies, Diabetes

Surgical Technologies sales increased 11% y-o-y to $418 million on account of balanced growth in its Neurosurgery, Advanced Energy and ENT businesses. Robust sales of Midas Rex power equipment and O-arm surgical imaging system helped Neurosurgery’s top line grow in double digits last quarter. ENT sales also registered similar growth aided by the growing adoption of new products such as the M5 Microdebrider and NuVent sinus balloon. [2]

Sales in the Diabetes division grew 6% y-o-y to $449 million, driven by solid uptake of the company’s MiniMed 530G system (with Enlite CGM sensor) in the U.S. as well as emerging markets. MiniMed is the first system in the market which has a built-in automatic control mechanism to start/stop insulin delivery in the blood based on pre-determined insulin levels. Medtronic estimates that this product could drive sales significantly in the near term as it expands internationally focusing on the type-2 diabetes market.

Spine Reports Modest Sales Growth

The Spine division reported an improvement over its performance in the last few quarters, with operational sales increasing 2% y-o-y to $740 million. Sales improved on account of a recovery in the Core Spine business in the U.S. as well as in international markets. The Interventional Spine business, consisting primarily of Balloon Kyphoplasty Procedure products, reported flat sales owing to low-single digit growth in the U.S. and Japan which offset weak sales in Europe. Spinal sales are expected to get a boost in the coming quarters with the recent launch of several new products including the Divergence Anterior Cervical Fusion System and the titanium-coated Interbody Fusion Devices. The company is also in the process of launching its FDA-approved Prestige LP next-generation cervical disc in the U.S. market very soon. [3] ((Interbody Fusion Device -Press Release, Medtronic, Oct 20, 2014))

Solid Growth In Emerging Markets

Emerging markets contributed about 29% of overall international revenues and saw robust growth of 12% y-o-y to $542 million. In emerging markets, Africa and the Middle East were again strong performers, with revenues growing over 22%. Other regions such as Europe and Latin America also registered double digit growth.

Medtronic expects sales from emerging markets, including Asia-Pacific, Latin America and South Asia, to continue to grow in the mid teens as it works on optimizing its business channels and establishes sustainable and broader business partnerships with national governments. The medical device major expects emerging markets to contribute 150 to 200 basis points to its overall sales growth in fiscal 2015. [1]

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Notes:
  1. Medtronic’s CEO Discusses F3Q 2015 Results – Earnings Call Transcript, Seeking Alpha, Feb 17 2015 [] []
  2. Visualase Press Release, Medtronic, July 28 2014 []
  3. Divergence -Press Release, Medtronic, Oct 21, 2014 []