Medtronic Earnings Meet Expectations But European Weakness A Concern

Medtronic (NYSE:MDT) announced its third quarter earnings for fiscal 2013 on Tuesday, registering mid-single digit growth in revenues, in-line with our expectations. ^[1] Overall revenue grew by 4% to $4 billion, excluding the currency impact. The medical device maker’s key division, pacemakers & defibrillators along with spinal franchise continued to witness a decline in sales. However, growth in cardiovascular, diabetes and surgical technologies businesses more than offset the decline. Gross margins declined slightly mainly due to foreign exchange fluctuations. Below we highlight the key trends coming out of the earnings release.

See our complete analysis of Medtronic here

Revenues Grow, But European Weakness A Concern

On a quarterly basis, the medical device maker recorded a 1% decline (excluding the currency effect) in revenue from pacemakers & defibrillators division as pricing pressure weighed on growth even as overall procedural volumes were stable during the period. ^[2] Bulk purchases from hospitals were down on a year-over-year basis which impacted growth. Growing troubles for one of its largest competitors, St. Jude Medical, helped Medtronic a bit. Growth in its leads (that connect ICDs to heart) sales following fresh troubles for St. Jude was expected. The lead-to-port ratio, which measures the number of leads sold relative to the number of ICDs or ports, continued to increase during the period.

While the demand for pacemakers was weak, sales got a little support from the launch of  MRI-conditional pacemaker in Japan. ^[2] However, what comes as a concern for the whole division is that management is seeing more weakness in European markets as procedural volumes decelerated in January. This could continue to weigh on growth in the near term. ^[2]

As expected, the spinal division witnessed a decline due to weaker demand for its main product Infuse, a bone graft paste used in spinal surgery even as new products are gaining broader acceptance. Stronger sales of heart valves and heart stents in the cardiovascular segment, however, more than offset the aforementioned decline in revenue. Resolute Integrity, a drug eluting stent (DES), saw a strong pick-up in demand following the launch in international markets including Japan. The stent has been performing well in the U.S. market as well. ^[2]

Sales from the surgical technologies division continued to exhibit a strong performance on increasing demand for navigated spine procedures. This justifies our view that the division will soon overcome the company’s diabetes franchise in sales even as the latter maintains moderate growth on insulin pumps. ^[2]

While the overall contribution of emerging markets to the company’s total  revenue stands at 12%, Medtronic is gradually moving towards its target of 20%. Sales from emerging markets continued to exhibit double digit growth (21%), excluding currency impacts, and drove international growth. ^[1]

A strong U.S. dollar and pricing pressure continued to weigh on overall gross margins. However, operating profit jumped due to various cost cutting measures undertaken to fend off expected slow growth in the near term. The medical device maker is planning to cut as much as $1.2 billion in costs in the next few years. ((ref:2)

Long Term Outlook Strong

In the short term, a weak Europe and pricing pressure continue to pose a concern for the medical device maker. Further, an unfavorable currency could also continue to weigh on its growth. In addition, beginning 2013, new medical device taxes have come into effect following Patient Protection and Affordable Care Act, or ObamaCare, and will weigh on operating profit.

However, the longer term outlook for Medtronic looks sound. The company has been launching several new and innovative products at continuous intervals, which should drive growth going forward. Medtronic holds FDA approval for Revo MRI SureScan, the first MRI-safe pacemaker. In addition, new devices in the cardiovascular business have mostly exhibited better treatment opportunities and are seeing greater sales in the regions where they were launched. Recently, the medical device maker reported impressive one-year results from its Symplicity HTN-2 study for its renal denervation device (a radiotherapy-based system to treat high blood pressure), Symplicity, which will strengthen its case to secure FDA approval for the device (Read Medtronic: Good Symplicity Test Results But FDA Approval Not Close)

Further, Medtronic is actively pursuing the inorganic route in the Chinese market (Read Medtronic Eyes M&A To Tap Chinese Market Growth). The recent acquisition of Chinese medical devices maker China Kanghui Holdings signifies its intention (Read Medtronic Pays Princely Sum For Greater China Access With Acquisition). Emerging markets, including China, have been experiencing double-digit growth so any move toward making inroads into these markets will only help Medtronic fend off weakness in developed markets.

We are in the process of updating our price estimate for Medtronic to reflect the Q3 results and recent trends.

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1. Medtronic Reports Second Quarter Earnings, Medtronic, Feb 19 2012 [↩] [↩]
2. Medtronic’s CEO Discusses F3Q 2013 Results – Earnings Call Transcript, Seeking Alpha, Feb 19 2013 [↩] [↩] [↩] [↩] [↩]