Alan Brochstein takes another look at medical-device companies
It has been almost two years since I first shared my bullish view on the medical device industry on the TradeKing All-Star blog. Since then, the group's performance has generally improved, in some cases significantly. Despite the recovery in prices, with several moving to all-time-highs recently, I still find these stocks to be very attractive value plays, especially for conservative investors.
Before reviewing some of the companies that comprise the industry, I wanted to update my bullish thesis. This industry tends to have high margins, reflecting limited competition, strong and productive R&D, good balance sheets and very favorable demographics (aging population). One of the more interesting characteristics is the high international exposure, and many of these companies are growing their emerging market sales quite substantially. I believe recent economic trends have distracted investors who have focused too much on short-term results rather than longer-term opportunities.
Here is a table with data on all the medical equipment stocks with market capitalization in excess of $5 billion:



[click on the image above to enlarge it]
 
Please remember that none of these stocks should be considered as recommendations to buy or sell. You should always do your own investigation of the merits of any investment.
I sorted the list by P/E, with the companies with the lowest P/E ratios at the top of the list. Before commenting briefly on each of the companies, I want to point out that the group as a whole is outperforming the market so far in 2011, with a median return of 9% and a range of -9% to 41%. The median P/E ratio is at a slight premium to the S&P 500 at 14.9X, but these stocks have traded at much higher ratios historically. I have included the 5-year average to demonstrate this point. I also included dividend information as well for investors who are interested in income.
Medtronic (MDT) looks quite inexpensive to me, but there has been some uncertainty due to the sudden departure of the CEO and the hiring of an outsider to replace him. Much of its historical growth has come from acquisitions. I continue to prefer its rival, St Jude (STJ).
Covidien (COV) was spun out of Tyco a few years ago and looks to be on track now, recently printing an all-time high. The company is highly diversified.
I follow Zimmer (ZMH) somewhat closely. It has suffered from changes in marketing practices that have impacted the hip and knee implant manufacturers. Despite the market's recovery, the stock retains one of the lower valuations in the industry.
Johnson & Johnson (JNJ) has certainly suffered from a series of recalls in its consumer products franchise as well as patent expirations in its pharmaceutical division. Medical devices, its largest segment, has faced industry challenges but seems to be performing relatively well. The stock recently moved to a two-year high and is within 10% of its all-time high set in 2008.
St Jude (STJ) remains one of my favorites in the group despite increasing from $33 when I profiled it in the original blog post. The company, with primarily a cardiac/cardiovascular focus, has exceptional management and a robust pipeline of new products. It has pulled back somewhat sharply after posting an all-time high in April.
Baxter (BAX), whose products are focused on blood treatments and monitoring, had a couple of major setbacks last year, but that looks to be behind them now.
Becton Dickinson (BDX), which is focused on hospital infection prevention and diabetes care, has performed well and is sitting just beneath its all-time high.
I used to follow Hologic (HOLX) more closely and should probably take a closer look. They are focused on various aspects of women’s health, including breast and gynecological diagnostics. 
I recently added Carefusion (CFN) to my watchlist. It was spun out of Cardinal Health (CAH) and hired a fantastic CEO, in my view, recently. The company is focused on intravenous infusion, medication dispensing, respiratory care and infection prevention.
Stryker (SYK) competes with ZMH and also sells equipment to hospitals. The company is well-managed in my view.
I have downgraded my near-term view of C.R. Bard (BCR) due to the strong performance after they issued debt to repurchase a significant amount of stock, driving the price to an all-time high and the valuation a bit above peers. Longer-term, I do like their diversification.
Boston Scientific (BSX) might well be the most troubled company in the industry (in my opinion, at least). Its P/E is high because its earnings have fallen rather than because it is viewed as a strong growth company like the three that follow. Their CEO departed suddenly recently. I don’t mean to sound negative about the name, though, but I want to make sure that I convey that this is a “turnaround” story, at least a potentially positive one. BSX has divested some businesses and has focused more on cardiac/cardiovascular.
Varian Medical (VAR) looks expensive to me, but that is usually the case for this great company that treats cancer with radiation. Investors like their steady growth and active share repurchase program.
Intuitive Surgical (ISRG) remains one of my favorite stocks in this industry due to its monopoly status as the only provider of robotically-assisted surgery. I described ISRG in great detail last December, using it as an example of what I called a “Good Company for 2011”. Despite the stock's 41% rise this year and a move to an all-time high close earlier this month, the stock looks attractive to me.
The most expensive stock on the list is Edwards LifeSciences (EW), but this company could have a key advantage in its new transcatheter valve, which has been approved in Europe and is likely to be approved in the U.S. within the next year. This new technology dramatically increases the number of patients who will be able to have their heart repaired. While the company has a first-mover advantage, there will almost certainly be others following, including STJ.
So, hopefully my brief comments on these large-cap medical device companies gives you a starting point for investigating this group further. I continue to believe that the industry is one of the more interesting components of healthcare. Investors who were disappointed by the slowdown as the economy contracted may return to this group as fundamentals improve over the next few years.

Regards,

Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

 

Disclosure:  Alan Brochstein is long BDX, JNJ and STJ in Invest by Model portfolio.


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