Medtronic reported strong 3Q FY18 sales and earnings results this morning. FY18 guidance and FY19 commentary were reiterated. Competition is still a threat to MDT’s growth, but we expect some tuck-in M&A to help, following the cash repatriation from the tax reform. Price target increased to $93.
Current Price: $81.65 Price Target: $93 (from $88)
Position size: 2.87% Performance LTM: +3.56%
Thesis intact. Key takeaways from the quarter:
1. Quarter review:
a. 3Q FY18 reported sales +1% (organic sales +7%):
i. Acceleration in growth from therapy innovation & product launches
ii. Value-based healthcare initiatives is driving growth across the business segments
iii. Some delays experienced in their surgical robotics program as the software/hardware integration is taking longer than expected. This product is a big growth driver for their Minimally Invasive Therapies segment, potentially adding 50-150bps of growth in FY19. This unexpected delay is causing the stock to retreat today
b. Operating margins +30bps y/y due to Covidien synergies
c. Adjusted EPS grew 12% y/y ex-FX
d. Net debt to EBITDA keeps declining, now reaching 1.6x
2. FY18 guidance reiterated:
a. FY18 sales growth guidance of 4-5%
i. Rising competition in most of its segments is moderating 4Q growth
b. Meaningful EPS leverage: growth ex-FX +9-10%
c. The management team confirmed some FY19 color provided last quarter: expecting MSD sales growth with Diabetes growing double-digits, operating margin expansion leading to EPS growth in the high single digit range
i. Acceleration from therapy innovation/product launches to continue
ii. Diabetes strength to continue as the manufacturing of its diabetes blood glucose sensor will be ready to meet the demand by the end of Q4 FY18. Also awaiting FDA approval for its stand-alone monitor
3. Valuation increased to $93 to reflect the recent strength in the business, illustrated by the FCF margin
a. We are valuing the stock on a blended P/E and FCF margin analysis:
i. 17x forward P/E (past 2 years historical average post Covidien acquisition), which we see as fair for a good quality stock that still has potential to grow MSD and delivering low teens EPS growth but is facing competition in the coming 2 years. However, multiple expansion towards peer group level is possible in the coming quarters as the company delivers on its sales growth target
ii. FCF margin analysis leads to a $97.8 price target
MDT Thesis:
· Stands to benefit from secular trends (1) increased utilization from Obamacare (2) developed populations age
· Strong balance sheet and cash flows. Increased access to non-cash should allow MDT to meaningfully increase their dividend
· 6% normalized Real Cash yield provides solid total return profile over next 2-3 years
· Ownership interest aligned. Management incentivized to maximize shareholder returns – 14% 10yr average ROIC
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