Image Source: U.S. Embassy Kyiv Ukraine
Today, June 2, Dividend Growth Newsletter portfolio holding Medtronic (MDT) reported its first results including business from recently-acquired Covidien. The acquisition was successfully closed on January 26, early in the fourth quarter of the firm’s fiscal year 2015, and was worth nearly $50 billion.
In its report, management presented results in a couple ways, one on a strictly-reported basis and the other on a constant-currency, comparable basis. The latter includes Covidien’s prior-year monthly results aligned to Medtronic’s fiscal quarters, which the company feels gives a more accurate picture of underlying performance and the success of the early stages of integration of Covidien. The strictly-reported basis, on the other hand, provides a better understanding of the impact that the merger has, and will continue to have, on the overall performance of Medtronic plc.
Medtronic experienced a solid quarter on its top line, with total revenue growing 7% on a comparable basis and 60% on a reported basis. Again, the incredible jump with respect to reported numbers is mostly due to the acquisition of Covidien; the top-line impact was clearly substantial. The firm performed well across all of its geographical divisions, experiencing 8% comparable revenue growth in the US, 5% comparable growth in non-US developed markets, and 11% comparable growth in emerging markets. Things are going great.
But despite strong revenue growth in the quarter, Medtronic realized a net loss of $1 million compared to a positive income of $448 million in the year-ago period. But we’re not worried. Gross margin decreased from 74.4% to 59.8% as a result of the ongoing integration of the legacy Covidien businesses. Other costs such as restructuring charges and acquisition-related items dragged the bottom-line down as well. It can be reasonably expected that these headwinds will eventually wane once integration is completed. In fact, we’re anticipating significant synergies related to the deal (beyond tax implications).
Though the acquisition of Covidien stole the headlines, Medtronic’s three pre-existing divisions continue to report solid numbers. The firm’s Cardiac and Vascular Group (CVG) reported ~$2.6 billion in revenue, growing 10% on both a comparable and reported basis. Within CVG, the Aortic & Peripheral Vascular division was boosted substantially by the performance of the legacy Covidien business. The company’s Restorative Therapies Group (RTG) grew revenue 5% on a comparable basis to ~$1.85 billion, and its Diabetes Group, the smallest of the groups, grew 2% comparably. RTG experienced the positive effects of the addition of legacy Covidien’s neurovascular division, a segment formerly non-existent at Medtronic.
The newly-created Minimally Invasive Therapies Group (MITG), formerly the Medical Care Solutions division of Covidien, was the main source of the growth in reported revenue. MITG reported worldwide sales of ~$2.4 billion, growing by 6% on a comparable basis. In other words, Medtronic was able to grow the top line of a brand new segment by 6% in the very first quarter it ran the business. Though some momentum can inevitably be expected, this is a great sign for the continued integration of MITG and the other legacy Covidien businesses.
We liked Medtronic before its acquisition of Covidien, and we continue to like the company now. The combined entity is presently the second-highest-weighted holding in the Dividend Growth Newsletter portfolio thanks in part to its fantastic share-price performance. Our forecasts in the firm’s 16-page report, which drive our fair value estimate of shares, mirror management’s fiscal 2016 guidance calling for 4%-6% growth on the top line (on a comparable organic basis) and non-GAAP EPS in the range of $4.30-$4.40 (we’re slightly higher on the bottom line with our estimate). Medtronic receives ratings of EXCELLENT on both our assessment of its dividend growth potential and dividend safety, registering an impressive Dividend Cushion ratio of 4.
Though Medtronic’s annual yield is comparatively small at only 1.6%, the company’s dividend has experienced continued growth since the early 2000s and should do so well into the future. The small yield in many ways has been a result of the firm’s strong share-price performance during the past few years, and we simply can’t be disappointed with the company because it has been successful in creating value for shareholders. The Valuentum Buying Index rating for Medtronic is 7 at the time of this writing, and we’re comfortable “letting this (big) winner run.” Shares are still trading below the high end of the fair value range, even if they have surpassed the midpoint.