Note: This report contains substantially new information. Subsequent reports will have changes highlighted.
Reason for Report:4Q14 Earnings Update
Prev. Ed.:Sep 25, 2014; 3Q14 Earnings Update (brokers’ material considered till Sep 5, 2014)
Brokers’ Recommendations:Positive: 29.4% (5 firms); Neutral: 70.6% (12); Negative: 0% (0) Prev. Ed.: 8; 9; 0
Brokers’ Target Price:$95.69(↑ $2.78 from the last edition; 14 firms) Brokers’ Avg. Expected Return:-6.5%
* Note: Though dated Dec 16, 2014, share price and broker materials are as Dec 3, 2014.
Note: The tables below (Revenue, Margins, and Earnings per Share) contain material from fewer brokers than in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
Covidien plc (COV) is a diversified large-cap medical technology company with exposure to the Medical Device and Supplies segments.
Of the 17 firms rating the stock, 12 firms (70.6%)provided Neutral ratings while 5 firms (29.4%) conferred Positive ratings. Out of these, 14 firms provided an average target price of $95.69. Target prices for Covidien range from $70 to $115.
Neutral or equivalent outlook (12/17 firms):Neutral firms view the acquisition of Covidien by Medtronic for approximately $43 billion as a positive. They believe that the buyout price fairly values Covidien’s assets. They further believe that chances of another Medtech bidder emerging are limited as few companies have the balance sheet flexibility to finance a transaction of this size.
Given the complementary nature of products with little overlap, firms believe that the deal is a strategic fit. Moreover, the firms are encouraged by the recent regulatory approvals won by the deal. However, inversion deals like these have gained considerable attention in the political arena, which raises some risk of increased inspection.
Positive or equivalent outlook (5/17 firms): Bullish firms opine that Covidien offers attractive fundamentals, such as a diversified revenue stream, exposure to more stable areas of the medical technology sector and opportunities for profitable gains. According to them, Covidien is well positioned to sustain above-average sales or EPS growth over time with the launch of new products and continued focus on cost structure optimization. The firms are encouraged by the company's growth curve in the emerging markets along with investments in innovative products.
According to the firms, the company’s latest acquisitions are delivering better-than-expected results.As Covidien continues to streamline its portfolio, leverage from recent acquisitions, and invest more aggressively in key and fast-growth emerging markets, optimistic firms feel that the growth and profitability profile of the business should continue to improve.
Negative or equivalent outlook:
Conclusion: Firms believe that Covidien’s attractive fundamentals position it well to sustain above-average sales or EPS growth. Firms are also optimistic about the acquisition of Covidien by Medtronic which should improve the combined entity’s competitive position in the market. Moreover, the recent regulatory approvals won by the merger deal restore their confidence in the stock.
Dec 16, 2014
Overview
Covidien Plc is a global leader in the development, manufacture and sale of healthcare products for use in clinical and home settings.
The firms identified the following factors for evaluating the investment merits of Covidien:
Key Positive Arguments / Key Negative Arguments- Covidien has a history of developing and manufacturing high-quality products in a cost-effective manner.
- The company employs strict safety and quality control measures to reduce disruption throughout its supply chain.
- Covidien plans to step up product introduction, focus on faster-growingemerging markets, and increase market share in traditional segments through more investment in sales and marketing.
- Accelerating investment in R&D and marketing are expected to leave Covidien well-positioned to deliver long-term growth.
- The company is poised for multiple expansion based on its diversified business, ability to improve operating leverage and solid cash flows.
- The FDA clearance for the launch of the new Endo GIA Reinforced Reload with Tri-Staple technology in the U.S. repositions Covidien as the only company with this technology.
- Currency fluctuations, especially the Japanese yen, is negatively affecting top-line growth for Covidien.
- The Medical Device Tax along with pricing pressure is likely to affect the company’s bottom line.
- Covidien'score Medical Device business overlaps with the business of its competitors like Johnson & Johnson (J&J), Becton, Dickinson (BDX), and C.R. Bard (BCR).
- Difficult macroeconomic conditions are adversely affecting Covidien’s top line. Weakness in capital purchases and procedure volume remains a cause for concern. Sales in the U.S. continue to be soft.
After the spin-off of its Pharmaceutical Division (Mallinckrodt) on Jun 30, 2013, the company started operating through two segments: Medical Devices and Medical Supplies, effective Oct 1, 2013.
According to the new reporting structure, the results of the Medical Supplies segment in Western Europe have been reflected in the Medical Devices segment. Product line sales under Medical Devices segment have been reported in three categories: (i) Surgical Solutions (ii) Vascular Therapies and (iii) Respiratory & Patient Care. Also, sales are primarily based on customer location, i.e., (i) U.S. (ii) Non-U.S. Developed Markets and (iii) Emerging Markets, rather than location of the selling entity.
Surgical Solutions comprises Advanced Surgical and General Surgical product groups; Vascular Therapies comprises Peripheral Vascular and Neurovascular product groups; and Respiratory and Patient Care comprises Patient Monitoring, Airway & Ventilation, Nursing Care and Patient Care.
The Medical Devices segment (85.3% of total revenues in FY14) includes the development, manufacture and sale of a broad spectrum of endomechanical instruments, energy devices, soft tissue repair products, vascular products, oximetry and monitoring products, airway and ventilation products, and other medical products. The company offers its products to physicians, nurses, materials managers, group purchasing organizations and governmental health care authorities.
The Medical Supplies segment (14.7%) offers nursing care products, including those for wound care and surgery such as operating room supply products and related accessories. Supplies include electrodes, chart paper product lines, SharpSafety products, and original equipment manufacturer products including medical supplies such as needles and syringes, and incontinence products.
Further information on the company is available at its website:
Note: The company’s fiscal year ends on Sep 29; fiscal references do not coincide with the calendar year.
Dec 16, 2014
Long-Term Growth
Of the 17 firms covering Covidien, 8firms have provided an average long-term (3–5 years) earnings growth projection of 9.9% for the stock.
Optimistic firms view Covidien as an attractively diversified company given its broad product portfolio and strong global presence. Its solid product offering of medical devices and supplies is being supplemented by investments in innovative new products. In addition, the company is expanding into faster-growing emerging markets such as China. The firms believe that the breadth of the company’s product lines,along with new product offerings, investments and acquisitions are expected to drive growth gradually.
Covidien is one of the top medicaltechnology companies in the world. Favorable demographic trends, substantial investments by developing economies in their healthcare structure and consistent growth in emerging markets should propel top-line growth in the future. The company continues to execute smoothly as it divests under-achieving parts of the portfolio and gradually adds new technologies, products and businesses to the portfolio.
Following the divestment of the Pharmaceutical unit, Covidien reiterated its long-term goal of generating mid-single digit top-line growth and double-digit bottom-line growth. Additionally, the company retained its commitment to return up to 50% of its free cash flow to shareholders. The momentum in the core medical device business remains strong, and should result in steady top-line growth for the next several years.
Medtronic is slated to acquire Covidien for about $43 billion, with the deal expected to close in early FY15. Post-acquisition, Medtronic will relocate headquarters to Ireland, where Covidien is currently based. Though firms view thisas a positive for Covidien, inversion deals have recently gained considerable attention in the political arena, which raises risk of increased scrutiny.
The addition of several innovative productsinFY14 is expected to provide long-term growth prospects to the company.However, given the company’s diverse portfolio of products and technology, there will be issues with product performance, competition and regulatory risks that can evoke investor concern.
Dec 16, 20
Target Price/Valuation
Rating DistributionPositive / 29.4%↓
Neutral / 70.6%↑
Negative / 0.0%
Avg. Target Price / $95.69↑
Digest High / $115.00↑
Digest Low / $70.00
Upside from Current / -6.5%
No. of Analysts with Target Price/Total / 14/17
Risks to the price target include regulatory delays, aggressive pricing by the competitors, lower-than-expected utilization trends, reimbursement, raw material price hike,and a still stronger U.S. dollar and acquisition integration risks.
Recent Events
On Nov 5, 2014, Covidien reported 4Q14earnings results. Highlights are as follows:
- Total revenuesincreased 6.8% yearoveryear (y/y) to $2.73 billion.
- Adjusted EPSsurged 26.4% y/y to $1.15.
Latest Update on Merger with Medtronic
The proposed $42.9 billion merger between Medtronic, Inc. and Covidien, announced on Jun 15, 2014, is in its final leg as the deal has obtained several regulatory go-aheads and approvals in the last couple of weeks.
The deal was cleared by the Chinese Ministry of Commerce as well as the South Korean Fair Trade Commission on Dec 5, 2014. The European Commission conditionally cleared the deal on Nov 28 while it received a go-ahead from the U.S. Federal Trade Commission (FTC) on Nov 26, subject to the fulfillment of certain conditions. On the same day, the Canadian Competition Bureau also gave a green signal to the transaction.
Approvals by these agencies are conditional on Medtronic’s commitment to divest Covidien’s drug-coated balloon business. Presuming the same, a subsidiary of Covidien entered into an agreement to divest these assets to The Spectranetics Corporation. The divestiture is expected to close shortly following the completion of Medtronic’s buyout of Covidien.
As per the new financing plan unveiled on Oct 3, Medtronic revealed that it will not utilize cash from its foreign subsidiaries, as previously planned, but will take an external debt of $16 billion to finance a part of its $42.9 billion Covidien acquisition deal. The transaction is expected to close in early 2015 after gaining approvals from both the companies’ shareholders and the High Court of Ireland.
Acquisitions, Divestitures and Spin-Offs
On Nov 2, 2014, Covidien signed a definitive agreement with The Spectranetics Corporation (SPNC), under which the latter will acquire Covidien's Stellarex drug-coated angioplasty balloon (DCB) platform for $30 million. Designed to treat peripheral arterial disease, Stellarex DCB is part of Covidien’s vascular product line. Divesture of Stellarex DCB is subject to the approval of the FTC and other regulatory agencies, as well as closure of the Medtronic-Covidien merger, which is slated to be complete by early 2015.
Revenues
Revenues in 4Q14 increased 6.8% to $2.73 billion, driven by robust performance across all the segments.On a geographic basis, revenues in the U.S. increased 6.3% y/yto $1.38 billion. On the other hand, revenues from non-U.S.developed markets rose 4.2% to $914 million, whereas revenue growth in emerging markets was 14.1%, reaching the figureto $445 million.
Provided below is a summary of total revenue as compiled by Zacks Digest:
Revenues ($ in M) / 4Q13A / 3Q14A / 4Q14A / 1Q15E / 2014A / 2015E / 2016E / 2017EDigest High / $2,560.2 / $2,688.0 / $2,734.0 / $2,740.0 / $10,659.0 / $11,047.3 / $11,473.3 / $11,966.0
Digest Low / $2,560.0 / $2,688.0 / $2,734.0 / $2,696.8 / $10,659.0 / $10,965.0 / $11,436.0 / $11,954.0
Digest Average / $2,560.0 / $2,688.0 / $2,734.0 / $2,712.2 / $10,659.0 / $11,002.6 / $11,459.6 / $11,960.0
Y/Y Growth / 2.4% / 4.3% / 6.8% / 2.8% / 4.1% / 3.2% / 4.2% / 4.4%
Q/Q Growth / -0.7% / 3.5% / 1.7% / -0.8%
Outlook:Bullish firms expect Covidien to generate 4–5% of organic revenue growth going forward, driven by new product offerings and growth in emerging markets for the Medical Devices segment. Investments in the international markets are paying off and firms expect encouraging results from this key growth driver in the coming years as well.
MEDICAL DEVICES
Revenues from the larger Medical Devices segment increased 7.5% y/y to $2.3 billionin 4Q14. The division is benefiting fromproduct launches and higher volumes. Moreover, it experienced solid gains in the emerging markets, particularly in the BRIC countries, reflecting investments and acquisitions made over the past few years.Australia also registered double-digit sales growth.
Product Group Results
Surgical Solutions: Surgical solutions sales increased almost 11% to $1.33 billion. Stapling posted considerable growth in the quarter. Vessel sealing, interventional lung, synthetic mesh and Covidien’s BARRX gastrointestinal business achieved double-digit sales growth. Given Imaging takeover also drove advanced surgical sales.
Operational sales growth was 12%, as foreign exchange rate movement reduced the quarterly sales growth rate by one percentage point. Within Surgical Solutions, Advanced Surgical operational sales were substantially above those of the prior year, while General Surgical operational sales were about level with those of a year ago, primarily as a result of the sale of the Confluent biosurgery product line in January 2014, partially offset by the impact of recent acquisitions.
Vascular Therapies: Vascular Therapies sales climbed up 3% to $426 million, on both a reported and operational basis, due to higher neurovascular sales. The increase was driven by double-digit sales growth in both stents and access delivery products and higher sales of coils and flow diversion products. Peripheral Vascular sales grew modestly during the quarter, with increases in sales of chronic venous insufficiency and procedural support products, partially offset by decreases in sales of compression and dialysis products in the U.S.
Respiratory and Patient Care: Respiratory and Patient Care sales inched up 3% to $974 million. Patient Monitoring sales increased 6% y/y, primarily resulting from increased sales of capnography products, which continued to grow well above 20%.
Airway & Ventilation sales grew modestly in the quarter due to increased sales of ventilators. Nursing Care sales increased slightly on a year-over-year basis, led by increased sales of wound care, enteral feeding and incontinence products. Patient Care sales grew slightly primarily due to higher sales of electrodes and OEM products.
Details of the product groupsare as follows:
Revenues ($ in million) / 4Q13A / 3Q14A / 4Q14A / 1Q15E / 2014A / 2015E / 2016E / 2017ESurgical Solutions / $1,202 / $1,305 / $1,334 / $1,323.7 / $5,113 / $5,358.2↑ / $5,631↓ / $5,928
Vascular Therapies / $413 / $417 / $426 / $427.8 / $1,677 / $1,707.1↓ / $1,790.5↓ / $1,864
Respiratory & Patient Care / $945 / $966 / $974 / $963.3 / $3,869 / $3,946.8↓ / $4,033.5↓ / $4,162
Provided below is a graphical presentation of product group revenue as compiled by Zacks Digest:
MEDICAL SUPPLIES
Revenues from the U.S. Medical Supplies segment went up roughly 2.6% y/y to $395 million in 4Q14.
New Products and Recent Developments
On Nov 24, 2014, Covidien obtained 510(k) clearance from the U.S. Food and Drug Administration (FDA) for its Fortrex over-the-wire percutaneous transluminal angioplasty (PTA) balloon catheter. Fortrex PTA balloon catheter is designed for both maintaining arteriovenous (AV) access for hemodialysis and treating peripheral artery diseases. The FDA clearance of this device strengthens Covidien’s existing PTA portfolio, providing clinicians an advanced solution to improve AV access in patients being treated with hemodialysis.
On Nov 20, 2014, Covidien announced the receipt of CE Mark approval for its Nellcor Bedside SpO2 Patient Monitoring System (PM100N). The Nellcor Bedside SpO2 Patient Monitoring System provides clinicians real-time patient respiratory status information including continuous SpO2, pulse rate monitoring and trending data. This allows clinicians to evaluate a patient's clinical course and detect and respond to dangerous respiratory events sooner.
On Nov 4, 2014, Covidien announced FDA 510(k) clearance of its HawkOne directional atherectomy system designed for the treatment of peripheral arterial disease (PAD). Covidien’s HawkOne system provides physicians with an enhanced cutting mechanism to more effectively treat the widest variety of plaque in patients with PAD.
On Oct 28, 2014, Covidien announced the launch of the first of its kind ReliaTack articulating reloadable fixation device, designed for laparoscopic (minimally invasive) hernia repair. ReliaTack delivers superior access, stronger fixation and lower cost of care. The device received FDA 510(K) clearance in Apr 2014.
On Oct 27, 2014, Covidien unveiled a next-generation version of its superDimension Navigation System software. The updated software features a more intuitive interface that helps reduce time spent by physicians planning the procedure and enhances the visualization of the airways of the lung. The navigation system enables a minimally invasive approach to accessing difficult-to-reach areas of the lung, which can aid in the diagnosis of lung diseases.
On Oct 9, 2014, Covidien received FDA 510(k) clearance for its Nellcor Portable SpO2 Patient Monitoring System (PM10N). It is the only commercially available portable oximeter that features home care and sleep study modes. The monitoring system is compatible with the entire line of Nellcor sensors with OxiMax technology. It offers a monitoring feature set including SpO2, pulse rate, SatSeconds alarm management, pleth waveform, blip bar and tabular trend information.
On Sep 18, 2014, Covidien announced the expansion of its Sonicision Cordless Ultrasonic Dissection Device portfolio, following the U.S. Food and Drug Administration (FDA) clearance for three additional device lengths − 13 cm, 26 cm and 48 cm. The newly-approved device lengths allow surgeons to expand their use of the Sonicision system to a more diverse range of surgical procedures, including pediatric colectomy, splenectomy, and appendectomy.
Please refer to the Zacks Digest spreadsheet on COV for further details on revenue estimates.
Margins
Gross margin expanded 260 basis points (bps) from the year-ago quarter to 60.8%, largely led by the company’s ongoing manufacturing cost reduction programs and favorable impact of foreign currency exchange.
Adjusted selling, general & administrative (SG&A) expenses, as percentage of revenues, declined 130bps yearoveryear. The decline can be primarily attributed to productivity improvements, partially offset by higher acquisitions expenses and transaction costs related to the company’s pending acquisition by Medtronic.