This blog is devoted to helping investors make informed decisions. It will be regularly updated and provide opinions on earnings results. It is not intended to give investment advice and should not be taken as such. Consult your investment advisor.
For long term investors it’s always interesting to find companies
that are undergoing structural changes which can unleash inherent value.
These situations create opportunities for discerning investors. I think
one such company is Covidien $COV and the recent results confirmed the progress that the company is
making. The underlying performance of its largest medical device
products remains strong and the future spinoff of its pharmaceutical
division will create even more opportunity for its strong cash flow
generation to be returned to shareholders. In summary, despite the
superficially mundane performance, I think the underlying story is a
good one.
Covidien Reports Good Results
The company beat adjusted EPS estimates by a cent but declared that
the next quarter would be sequentially lower. Now given that the
consensus for the next quarter is $1.06 this can be taken as Covidien
guiding a bit lower. Don’t get stressed though, this is largely because
of adverse currency movements and the fact that this year’s numbers will
contain one week’s less trading.
In fact, all medical device product lines recorded positive growth,
but currency headwinds reduced growth by 1-5% across the board. In
particular the largest product line (Endomechanical) saw operational
growth reduced to a reported 1% thanks to currency headwinds of 5%. No
matter, the company is doing OK and notably outperforming the medical
technology market. For example Johnson & Johnson SJNJ reported
nowhere near this kind of growth in its medical device division.
Indeed, I think the Synthes acquisition is evidence that JNJ is focusing
away from surgical procedures within its medical device division. This
is good news for Covidien.
Largest Product Lines Growing the Fastest
The usual suspects of Energy and Vascular were very strong in this
quarter. Endomechanical growth is definitely moderating and management
talked of negative results with mechanical fixation devices due to
competitors launching new products in the market place. It also has to
deal with longer term competition coming from robotic technology
companies like Intuitive Surgical $ISRG and Mako Surgical $MAKO. Both of whom are trying to expand the surgical procedures that their products are routinely used in.
Intuitive is seen as being very strong in one-off types of
procedures, so a health center will be able to add volume by buying one
of their machines. However, a general surgeon can perform all sorts of
different operations and he/she will not be so inclined to outlay the
expense of buying an Intuitive machine. As for Mako, the company
recently cut its sales forecast for the second time in the last few
months. Perhaps the march of the robots is not as inevitable as many
think it is?
On the other hand, Covidien is doing fine and investors should note
that the three biggest product lines within medical devices are Vascular
(21.2%), Energy (16.8%) and Endomechanical (30.5%) and –on an
operational basis- they grew 15%,13% and 6% respectively.
Here is the revenue breakdown for the medical device division.
In order to demonstrate how well the three largest divisions are
doing, here is the separation of Endomechanical, Vascular and Energy
from the rest.
It is noticeable how strong the trends in the most important product lines are.
New Product Launches
Covidien launched a number of new product launches in 2012 which lead
to supra-industry growth, but is it sustainable? There are two reasons
why it may well be. Firstly, medical device sales usually hit their peak
a few years after their launch so what is launched in 2012 will feed
into growth in future years. Secondly, investment in R&D remains
healthy and Covidien can also expand its new products into new markets.
Management affirmed its confidence that Sonicision (a cordless
ultrasonic dissection device which will allow surgeons more flexibility
in the theatre) was receiving very positive feedback.
Geographic Opportunities Mixed
On a geographic basis, Covidien is seeing no change in the US as
conditions remain repressed. This is somewhat surprising as hospital
admissions appear to be trending up and its strength is in non-elective
procedures. In other words, surgical revenues should be correlated with
admissions. As for Europe, conditions remain challenging with Spain
noticeably deteriorating in the quarter. Asia growth remains strong. In a
sense, Covidien’s geographic commentary could be scripted in common
with for all the other medical device companies right now, but the
company is outperforming its peers and the opportunity to expand its
products into emerging markets is a good one.
Covidien’s Growth Performance and Growth Prospects
I think Covidien is outperforming thanks to its research and
development profile. Ever since the Tyco spin off, management has been
able to focus and invest for growth. Product innovation has been notable
in Energy which has generated double digit growth for a long time now
as minimally invasive surgery (MIS) increasingly demonstrates better
patient outcomes and ultimately saves hospitals money. This kind of
investment produces results even in weak end markets.
In a similar way, investors can look forward to more of the same in
the run up to the spinoff of the pharmaceutical division. The spinoff is
on track and as a mark of confidence Covidien announced that they would
be increasing the level of intended cash flow return to investors to
50% from the historical target of 25-40%.
Future growth prospects
Returning cash and spinning off divisions is one thing but the best
equity investments are all about growth. The company's aim is to
continue to benefit from the increase in penetration of MIS and to
expand its products within emerging markets. It also has growth
potential from the ramp up in sales in future years from the products
launched this year and finally hospital admissions appear to be on the
rise in the US and this should start to drop into the top line.
On a more negative note, Covidien does have some poorly performing
product lines and it isn’t the sexiest growth story around. European
exposure is an obvious worry and it operates in some fiercely
competitive markets. It isn't risk free.
On balance I think the company is doing the right things in order to
generate growth and returns for its shareholders. Cash generation
remains excellent and the underlying performance is good. On a
risk/reward basis the stock looks like a good value.
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