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SEE: A Checklist For Successful Medical Technology Investment
Broad, But Relatively Shallow, Shortfalls in Q1
St. Jude's first quarter was definitely a mixed bag. Relative to Wall Street expectations, the company posted only small misses on the top line and the operating income line, while below-the-line results actually led to a one-cent outperformance. On the other hand, almost every business category was soft.
Revenue was down about 3% on a constant currency basis this quarter. In the cardiac rhythm management business, sales fell 7% on an 11% decline in pacemaker sales and a 4% decline in ICDs. While it's still early, I'd suspect those results will be better than those of Boston Scientific (NYSE:BSX) and worse than Medtronic (NYSE:MDT), but I do believe St. Jude is losing pacemaker share.
Sales in cardiology were flat and neuromodulation was down 3%. Outside of the transcatheter heart valves sold by Medtronic and Edwards Lifesciences (NYSE:EW), these results are pretty consistent with both industry groups. Atrial fibrilation sales (ablation, mostly) were up only 7%, an unimpressive performance relative to the low-teens growth at Johnson & Johnson (NYSE:JNJ).
Where St. Jude did perform better was on the margin lines. Gross margin fell more than a point from the year-ago level, but came in about a half-point better than expected. Operating income was a similar, albeit somewhat weaker, story. Operating income declined 6%, but St. Jude's operating margin (which fell a half-point) was about 20bp better than the Street average (suggesting some loss of leverage through SG&A and R&D).
SEE: A Look At Corporate Profit MarginsIt Could Get A Little Darker Before The Dawn
While St. Jude management seemed cautiously optimistic, management guidance always needs to be taken with a grain of salt. In the case of St. Jude especially, there are reasons to worry both about the overall health of the cardiac rhythm management business as well as the company's market share as the controversy over the company's Durata leads continues to play out.
Longer term, though, I think there are some reasons for optimism. New products like a line of value-priced pacemakers and the Nanostim leadless pacer could rebuild some momentum in CRM. I'm also more optimistic than many sell-side analysts about the firm's potential in transcatheter heart valves and renal denervation. Likewise, I think St. Jude is making solid moves in atrial fibrillation, where new catheter introductions and the MediGuide platform could help the company compete against large rivals like Medtronic and Johnson & Johnson, as well as smaller players like AtriCure (Nasdaq:ATRC).
That said, St. Jude has shown recently that it's unwise to count the pipeline eggs before they hatch. Data for the company's PFO and left atrial appendage products weren't great, and it's harder now to argue for blockbuster potential in those products. The same could prove true in heart valves and renal denervation, where there will be ample competition in these growing markets.
SEE: Equity Valuation In Good Times And Bad
The Bottom Line
I think it's generally a bad idea to make drastic whipsaw changes to estimates, but I have revised my expectations on St. Jude a little lower. I'm now looking for long-term revenue growth of about 3% and long-term free cash flow (FCF) growth of 4%. Those numbers could well prove conservative if the pipeline pans out, but by the same token the near-term growth outlook could worsen dramatically if there's a recall tied to Durata.
Those growth estimates lead to a fair value target near $43 for St. Jude today. That's still below today's price, and it's well worth noting that I think I'm erring on the side of conservatism with those growth projections. Still, even in the somewhat overheated world of med-tech, investors can find alternatives that are both cheaper on a long-term basis and stronger in the near term.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
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