Medtronic (NYSE:MDT) operates in the sphere between two growing sectors: health care and technology. The constants in both of these industries are change and stable demand. It also means, however, that Medtronic will not always be a smooth ride.
That is exactly what may have some investors concerned after the company posted mixed earnings. Since the beginning of 2019, MDT stock is behaving much like a growth stock. And everything has been going up. As evidence to this, MDT stock is up over 25% in the past year. The industry average is just over 10%.
However, on February 18, Medtronic posted stellar profits but disappointed in revenue. The company generated earnings per share of $1.44. This was an 11% growth from the previous quarter and blew away analysts’ expectations of 6 cents per share.
But revenue was a different story. Medtronic’s sales did grow in the quarter. The $7.72 billion figure showed 2.6% organic growth. However, it was shy of analysts’ expectations for 3.5% top-line growth.
Medtronic is Investing in the Future of Surgery
One fundamental reason why investors may be proceeding with caution is Medtronic’s acquisition of Digital Surgery. This is part of a long-term strategy the company is pursuing to put itself on the leading edge of robotic surgery and surgery training solutions. The company previously acquired Mazor Robotics. Based in Israel, Mazor provides robotic-assisted surgery (RAS) systems.
Digital Surgery is involved in the use of artificial intelligence (AI) in surgery. But the company also focuses on data and analytics as well as digital education and training. Medtronic has said it will house Digital Surgery within its minimally invasive therapies group. In the press release about the acquisition, Medtronic stated that owning Digital Surgery “will strengthen the Medtronic robotic-assisted surgery platform and has applicability for the Medtronic broader portfolio.”
This is an emerging sector, but one for which Medtronic has high expectations. Medtronic points out that currently only 2% of all surgeries worldwide are performed with the help of robotic systems. However, that number is expected to experience double-digit percentage growth in the next few years. Both Medtronic and its chief rival in the space, Intuitive Surgical (NASDAQ:ISRG) are jockeying for position in this critical space. Medtronic predicts that in a decade robotic systems will help “change the face of surgery”.
However, whenever a company like Medtronic takes on debt, it is usually a sign that the company’s bottom line will be impacted. To that end, Medtronic says the purchase of Digital Surgery should be “immaterial” to its 2020 adjusted earnings.
And while there is anticipation that this acquisition will help Medtronic meet long-term financial targets, which is the type of thing investors like to judge that for themselves.
The coronavirus may impact future revenue projections
In the conference call following the earnings announcement, the company advised that the coronavirus may cause a softening in sales and profitability figures in the current quarter. This will be due to lower procedure volumes and manufacturing disruptions in China.
Medtronic currently generates just 7% of its global revenue from China. But that is a growing percentage. In the quarter just ended (which covered the outbreak of the virus), revenue grew 14%. The company’s CEO Omar Ishrak, who is stepping to down to take another roll in the company, said all of Medtronic’s manufacturing operations were up and running.
The company’s sales and profit guidance for the quarter did not include possible impacts from the virus. Medtronic promised further guidance in the coming weeks.
Is Medtronic a buy?
If you liked Medtronic stock before the earnings report was released, there’s no reason to stop liking it now. And here are three reasons why.
First, the company is a cash-flow generating machine. Free cash flow is important for any business, but particularly one, like Medtronic, that will have to promote its products and have cash on hand to fund research and development. Prior to this earnings report, Medtronic’s total free cash flow in the trailing 12 months was $6.3 billion.
Second, the company has a deep pipeline. One of the snares of healthcare stocks is that they can be overly reliant on one thing. Medtronic has multiple revenue streams. And, although the United States is responsible for over half of the company’s growth, Medtronic is expanding into other markets. As noted above, China is one such market. But the company is also expanding into other areas of South Asia, the Middle East & Africa, and Eastern Europe. And all these areas generated double-digit percentage growth in the past year. More importantly, it gives the company a broad diversification that does not make it overly reliant on a single country.
Third, the company is a dividend aristocrat. This means it has increased its dividend every year for at least 25 years. If investors are a little concerned that the stock is pricey at current levels, the reliability of a dividend is a nice safety net.