Download - MDT Intrinsic Value · Medtronic (MDT) is the largest standalone medical device company in the world. It has historically focused on cardiovascular devices such as cardiac pacemakers,

Intrinsic Value Assessment of

MEDTRONIC (MDT)

DECEMBER 7, 2017 This article was written in collaboration with Christoph Wolf from The Investor’s Podcast and Christoph Wolf Value Investing

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

IntroductionMedtronic(MDT)isthelargeststandalonemedicaldevicecompanyintheworld.Ithashistoricallyfocusedoncardiovasculardevicessuchascardiacpacemakers,implantablecardioverter-defibrillators,andartificialheartvalves.In2014,theacquisitionofCovidienaddedminimallyinvasivetherapiestoitsportfolio.Also,restorativetherapiesforthespineorbrain,aswelldiabetestreatmentareimportantparts.

WhileMedtronic’smarketpositionisextremelydominantanditsbusinessismostlyrecession-proof,the$50billiontakeoverofCovidienalsoweakeneditsbalancesheet.Doesitscurrentstockpriceof$82offeranattractiveentrypriceforinvestors?

TheIntrinsicValueofMedtronicTodeterminethevalueofMedtronic,let’sconsideritshistoryoffreecashflows.Happily,forinvestors,Medtronic’sbusinessisrathercapital-lightandoffersjuicymargins.Combinethiswithconstantlyrisingrevenues,andonegetsthefreecashflowseeninthechartbelow:Steadilyincreasingandalmostrecession-proof.AnotherthingthatisvisibleistheeffectoftheCovidientakeover.Afteraninitialdeclineduetotemporaryintegrationfriction,thecashflowshaverecentlygatheredpacebecauseofthelargerbusiness.

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MEDTRONIC (MDT)


Asonecansee,theresultsinthepasthavebeenveryimpressive,butweshoulduseaconservativeestimateofthefuturefreecashflow.Tobuildthisestimate,wemakeuseofanarrayofpotentialoutcomesforfuturecashflows.

Eachlineintheabovegraphrepresentsacertainprobabilityforoccurring.Weassumea20%chancefortheuppergrowthrateof7%peryear,a50%chancefor4%growth,anda30%chancefortheworst-casescenarioofnogrowth.ThisrathernarrowbandreflectsthefactthatMedtronicisoperatinginabusinessthatismostlyindependentoftheoveralleconomyandthatitsmarketpositionisextremelystrong.Therefore,thefutureofMedtronicisrelativelyeasytopredict–whichisahugeadvantageforinvestorstryingtoevaluatethebusiness.

Assumingthesegrowthratesandprobabilitiesareaccurate,Medtroniccanbeexpectedtogivea4.8%annualreturnatthecurrentpriceof$82.Now,let’sdiscusshowandwhythosefreecashflowscouldbeachieved.

TheCompetitiveAdvantageofMedtronicMedtronicpossessessomeuniqueadvantagesthatshouldallowittobeverysuccessfulinthefuture:

• ProductDiversification.Medtronichasbothhigh-marginproducts(likepacemakersorreplacementhips)andlower-marginoffersinitsportfolio(e.g.,itsstentbusiness).Theformercanactasafinancialbufferifthelessprofitablebusinessdeclines.DuetotheacquisitionofCovidien,Medtronicisnowamajorplayerinseveralcomplementarydevicesegments,whichfurtherboostsitsdiversification.

• EconomiesofScale.Developing,testing,andproducingmedicaldevicesrequiresavastandconnectedbusiness.Medtronicpossessesadominantmarketshareinseveralproducts.Forexample,itprovidesmorethan50%ofallimplantedcardiacpacersworldwide.Forsomeofitsproducts,Medtroniccanrelyonamorethan30-yearoldclinicalhistory.Smallerbusinessescannoteasilyreplicatethis.

• HighSwitchingCosts.Medicaldevicesareoftenuniquelydesignedbyeachcompany.Sincelearninghowtouseaspecifictypeofspineproductorartificialhiprequiresmuchexperience,training,andtime,surgeonsoftensticktotheproducttheyknow.




MEDTRONIC (MDT)


• LargeUntappedFutureDemand.Peopleinboththerichandemergingworldwillbecomeevenolderandnumerous.Thisarmyofpensionersvirtuallyguaranteesanincreaseddemandformedicaldevicesinthefuture.

OpportunityCostsWhenlookingatvariousinvestingopportunitiesonthemarkettoday,let’scomparetheexpectedreturnofMedtronictootherideas.First,onecouldinvestintheten-yeartreasurybondwhichisproducinga2.4%return.Consideringthebondiscompletelyimpactedbyinflation,therealreturnofthisoptionislikelybelow1%.Currently,theS&P500ShillerP/Eratiois31.4.Asaresult,theU.S.Stockmarketispricedata3.2%yield.IfoneweretoinvestintheS&P500,theymightpurchasealow-costETFtotakeadvantageofthisreturn.

MacroFactorsMedtronic’sbusinessismostlyinsulatedfromthestateoftheeconomy.Ifyouneedaheartsurgeryorhavediabetes,youcannotwaituntiltheeconomyimproves.Thatsaid,theoverallcostintheU.S.foratotalkneereplacementcanbeabove$10,000,andapermanentcardiacpacemakercanevencost$50,000ormore.Thesehighpricesmightbelessaffordableinadownturn–nomatterhowurgentlytheyareneeded.Thisisespeciallytruebecausenotallcostsarecoveredbythehealthinsurances.

RiskFactorsThereareseveralrisksthatmightlimitthegrowthprospectsofMedtronic:

• WeakenedBalanceSheet.TheCovidienacquisitionblewahugeholeintothebalancesheet.Now,anenormousamountofalmost$40billiongoodwillispresent,andthelong-termdebthasballoonedtoover$25billion.Whilethecompanyremainsfinanciallystable,thisposesadragonitsbusiness.

• Competitors.Despiteitsextremelydominantmarketposition,Medtronicfacespressurebothfromhigh-endandlow-endcompetitors.IntuitiveSurgical(ISRG)isanexampleofahigh-endrival,whosestate-of-the-artroboticsurgicalsystemefficientlyperformsminimallyinvasivesurgeries.Medtronic’slower-marginbusinessisalsovulnerabletolow-costcompetitors.Thisisespeciallytrueinpoorercountrieswherecustomerscannoteasilyaffordcostlyproceduresandoftenchooseacheapalternative.




MEDTRONIC (MDT)


SummaryMedtronicisanimpressivebusinesswithanextremelywidemoat.Despitesomechallenges,itcanbeexpectedtosuccessfullyoperateforalongtimecoming–evenmoresoaftertheacquisitionbyCovidien,whichfurtherimproveditspositionasmarketleader.Withanexpectedannualreturnof4.8%,thestockseemsfairlyvaluedtakingtheoverallvaluationofthestockmarket.

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