Should Medtronic Investors Hold On To The Stock?

Medtronic (NYSE:MDT) stock lost more than 35% this year, declining from $115 to $73. Interestingly, it has since spiked a little over 25% to around $92 (as of July 8, 2020). This means that the stock is about 20% below where it was at the beginning of the year. Why? While the recent spike is a result of broader market move driven by Fed stimulus, the fundamental demand problem is still weighing Medtronic down. While the company is selling ventilators to support the battle against Covid-19, hospitals have suspended elective procedures that use the company’s medical devices. The impact is so much that weekly revenue in April was down 60% yoy and overall first quarter revenue fell 26%. But is this all? There is more to this story. Trefis’ price for Medtronic is $111, about 20% above the market price of $92. Here is why. 

What Could Push The Stock Up?

The first trigger is the sales. We forecast Medtronic’s 2020 sales at $28.9 billion against $30.6 billion in 2019. While this means nearly a 5%-6% decline vs 2019, it is not bad at all given the situation. Comparatively, there are industries such as hospitality, leisure, retail, and airlines that are looking at 20%-40% drops in revenue for the full year. Furthermore, the headwinds are temporary. Once Covid-19 is under control, Medtronic is going to quickly get back to its previous growth trajectory. This is because hospitals are going to shift their priorities back to procedures that heavily use Medtronic’s equipment. Thus, we have forecast a rebound to $30 billion in sales in 2021, and factor in an improved growth in P/E multiple.

The second trigger is net margin. There are two things happening here. First, while margin may dip by more than 150 bps in 2020, we expect it to bounce back to 2019 levels in the year after. Second, Medtronic’s  net margin was on a growing trend before the pandemic hit, increasing from 21.5% in 2017 to 23.2% in 2019. The temporary dip is only a short term interference in an otherwise improving cost structure.

So What Does This Mean For Share Price?

The combination of the above will imply 2020 EPS of $4.59 per share. How much should the market pay for each dollar of Medtronic’s earnings? As a reference, to earn close to $4.59 per year from a bank, you’d have to deposit about $400 in a savings account today, which is about 90 times the desired earnings. But Medtronic is a much more risky business than putting money in a savings account. The medical devices industry is dynamic and competitive threats are one of the foremost concerns. In addition, sophisticated and critical devices require FDA approval – which in itself becomes a risk factor as rejection could mean millions of R&D dollars down the drain. Moreover, exports could be affected by trade tensions between the US and China, with the latter being one of the key markets for Medtronic. Another risk to consider is product liabilities. The crux is that you would want a lot more return for each dollar you invest. In other words, you will pay less for each dollar of return (P/E) you get compared to a safe investment like a bank.  Thus, we apply a P/E multiple of 24.2 for Medtronic, which is higher than the figure for previous years but still lower than one of its key competitors, Abbott. This multiple is a blended mix based on Medtronic’s historic figures, current trailing multiple, and forward looking multiple. This gives us a price of $111 for the company’s stock.

But Medtronic is not the only one, there are other stocks out there that can unlock value. For instance, which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.

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