Company Visits and Updates
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St. Jude Medical and Medtronic……
San Diego hosted this year’s meeting of the North American Society of Pacing and Electrophysiology. This annual symposium concerns the science behind healthy heart rhythm and medical devices that sustain it, crucial components of modern medical technology. As standards of living improve in the world, so also will sales of life-saving cardiac rhythm management devices.This was a great opportunity for me to look closer at the comparative products of Medtronic, St. Jude Medical, and Guidant. These companies compete in the pacemaker, defibrillator, heart valve, and angioplasty catheter markets. Implantible cardiac defibrillators is a particularly interesting area, because of double digit volume growth. A recent study conducted by the National Institutes of Health, known as "AVID" (Antiarrhythmics Vs. Implantable Defibrillators), demonstrated that devices were notably more effective than drugs in prolonging heart patients’ lives.
Medtronic appears to be the industry leader in implantible defibrillators, because of software features and ability to sense both atrial and ventricular rhythms. Medtronic is an exceptionally high quality business, in terms of their products, management, shareholder friendliness and principles of doing business. It has rewarded its shareholders with consistent annual growth exceeding 20% compounded over the past decade. The best way to describe the stock is that the only error has been selling it. At $50 per share, Medtronic is selling at 39 times this year’s estimated earnings per share, and at 33 times fiscal ’99 earnings per share. The stock market is pricing the company at a rather high level compared to intrinsic value. Accordingly, we would find significant dips irresistible.
St. Jude Medical was in a quandary five years ago. All they sold at that time were mechanical heart valves, and they held about an 85% market share of this rapidly saturating business. The cash flows were huge then, and continue huge today. Management invested the cash flood in building a pacemaker/defibrillator business through acquisitions. These acquisitions built revenues from $300 million to nearly $1 billion. Earnings per share did not grow over the five-year period because of dilution from the acquisitions, so stock performance has been disappointing. However, the greatly expanded base of St. Jude Medical offers great opportunity. Management expects substantial margin improvement as the disparate acquisitions are melded to run as one company. Accordingly, management expects exceptional earnings growth performance over the next several years.
Wall Street’s interest has shifted away from St. Jude Medical over the past five year building period, because of lagging earnings growth. We believe the tide has just turned for the comparatively cheap stock, correlating with a significant earnings improvement that is just getting started. At $35 per share, St. Jude sells at about 21 times this year’s estimated $1.63 earnings per share and at about 18 times next year’s estimates. A more optimistic assessment from Wall Street should increase the p/e ratio.
In the long run, we would prefer owning Medtronic. An opportunity to exchange the St. Jude for Medtronic at the same stock price is an interesting possibility.
Steven L. Re¢ , CFA
May 8, 1998