By Nancy Zambell
Editor of Investment Digest and Dividend Digest
The population of the U.S. is aging. The over-65 age group grew by 18%—to 41.4 million—from 2000 to 2011. But we’re not the only country that’s growing old. By 2050, it’s estimated that the number of citizens in developing countries over the age of 60 will increase from 23% to 32%.
While many of us look forward to our golden years, they will most likely be more enjoyable with the assistance of an artificial part or two. I live in a resort-retirement area, where it’s common for the cocktail hour talk to turn to my neighbors’ new hip, knee or shoulder joints, or their latest surgery to replace heart valves and stents.
The business of medical devices is huge—running to sales of about $127.1 billion in 2013—and growing. There are several reasons for the expansion.
Emerging Markets are the Sweet Spot for the Industry
The United States is the largest market for medical devices, followed by Europe, but emerging markets are the sweet spot for the next wave of growth. According to Emergo Group’s recent survey of medical device makers, the highest percentage of sales increases in 2013 occurred in the Asia-Pacific Region (nearly 59%).
The global industry is expected to reach $302 billion in 2017, spurred by growth in surgical, cardiovascular, home healthcare, general medical and other devices, especially in China, India and Mexico.
Right now, China is the third-largest global market for medical devices in the world ($20 billion, but it is forecast to take over second place within the next few years—growing to $53.5 billion, according to RnR Market Research—as it gets closer to its 2020 goal for universal healthcare. The good news for us is that 31% of those devices are expected to come from the U.S., due to the perception that the devices are higher quality and more dependable, allowing U.S. exporters to charge premium prices.
India’s market—currently around $5.1 billion—is forecast to expand by 16% per year through 2017, as a result of its growing economy and the rising number of its 300 million middle class citizens who now have medical insurance.
Mexico’s medical device market, at $4 billion, is also on the rise. Due to reasonable prices, as a result of the North American Free Trade Agreement (NAFTA) regulations and medical tourism, the country is attractive to medical device manufacturers.
Burgeoning Regulation is Creating M&A Opportunities
The medical device industry is very fragmented. About 80% of companies in the sector have 50 or fewer employees. Currently, North America is responsible for 46% of the worldwide market. And with governmental regulations such as the Affordable Care Act and its associated medical device tax chipping away at profit margins, we have seen a proliferation of marriages and partnerships as larger companies with deep pockets court their smaller competitors.
Last year, Johnson & Johnson (JNJ) purchased surgical-device company Guangzhou Bioseal Biotech. Stryker (SYK) recently bought Chinese orthopedics company Trauson Holdings—maker of implants to treat spinal-cord injuries. Medtronic (MDT) took a 19% interest in LifeTech Scientific, a Chinese maker of stents and other vascular implants. Medtronic also formed an alliance—investing $24 million in R&D and manufacturing—with India’s Apollo Hospitals, to treat kidney damage. And Medtronic also bought Chinese orthopedics company Kanghui Holdings.
Market Leader Medtronic is the One to Beat
You’ll note that most of the acquisitions and alliances I just discussed were business combinations by Medtronic. That’s because I believe that Medtronic (MDT)—the world’s largest maker of heart rhythm devices—is in the right place at the right time to profit from the emerging markets and the M&A trends that are running rampant throughout the industry.
The company is not only the #1 maker of heart rhythm devices, but also holds leading market share in just about every product segment in which it operates, including the neuro/ortho and diabetes markets.
Medtronic’s pipeline of products is enormous and includes pacemakers, implantable defibrillators, coronary and peripheral stents, open heart and coronary bypass grafting surgical products, bone graft substitutes, implantable neurostimulation therapies, external insulin pumps, image-guided surgery and intra-operative imaging systems.
About 12% of its revenues come from emerging markets, an area that grew 12% for Medtronic in fiscal third quarter, which ended January 31, 2013.
The company’s balance sheet is solid, with lots of cash ($13.7 billion) as of the end of the quarter, which provides it with plenty of opportunities for growth—both internal and external. And its net profit margin—at 22.74%—is more than double the industry’s average of 10.23%.
Medtronic delivered 4% revenue growth in the quarter (above estimates), with earnings of $762 million, or 75 cents per share. Earnings came under pressure due the failure of the company’s Symplicity renal denervation technology trial. But its transcatheter heart valves (CoreValve) are a bright spot of growth.
The CoreValve received faster-than-anticipated FDA approval and has so far shown better efficacy for heart patients than competitive valves by Edwards. CoreValve is part of Medtronic’s Cardiovascular Division, which accounts for some 20% of the company’s revenues, and is seeing strong demand in international markets. By the end of this year, it is expected that CoreValve will see U.S. sales of as much as $50 million to $70 million.
Cardiac Rhythm Disease Management (CRDM) is about 30% of the company’s business, and grew 5% in the most recent quarter. Its Neuromodulation segment’s sales rose 6%.
For the fourth quarter and 2014, the company said it expects revenue growth of 3%-4% and fiscal year 2014 EPS in the range of $3.81 to $3.83, about a 6% growth rate.
While those aren’t barn-busting numbers, I think the opportunities in the emerging markets are going to propel this stock much further than the numbers indicate. And along the way, investors will receive a nice dividend yield of 1.9%.
Medtronic has increased its dividend for 35 consecutive years, and many analysts think the $1.12 per share could double within the next few years.
Investors have been piling into the shares in the last few months, along with insiders who have recently bought 2.3 million shares, institutional investors who have purchased 31.2 million shares, and options buyers, 87% of which are bullish on the stock.
But I think the stock’s appreciation is far from over. You can buy it now, enjoy the dividends, and hang on for further gains.
Editor of Dick Davis Investment Digest
And Dick Davis Dividend Digest