The medical devices industry, which was once acclaimed for its
high-paying jobs and research and development opportunities, has
been subject to the much controversial 2.3% medical device excise
tax since its enactment in the beginning of 2013.
Sequestration-related spending cuts to the U.S. federal budget have
also undermined the medical devices industry's prospects. In fact,
this has significantly restricted the industry's bottom-line
improvement in the past year.
Partial Repeal: A Boon?
However, as a slight respite, in Jan 2014, the National Institutes
of Health (NIH) got a $1 billion or 3.5% boost to its fiscal 2014
budget from the prior-year post-sequestration budget (according to
fiscal 2014 Omnibus Appropriations bill, released on Jan 13, 2014).
According to a statement by appropriators, this hike, although
insignificant, is expected to result in 385 million new grant
opportunities for researchers compared to 2013. We note that the
sequestration, which resulted in a 5.5% cut in the NIH fiscal 2013
budget, resulted in 640 fewer grants in 2013.
Apart from NIH, the National Institutes of Standards and
Technology, The National Science Foundation (NSF), health
professions and nursing workforce development programs are some of
the others to gain from this bill.
The U.S. Food and Drug Administration (FDA) has also managed to get
$2.552 billion through this omnibus spending package, a $166
million (7%) increase over the fiscal 2013 post-sequestration
funding level. The Centers for Disease Control and Prevention (CDC)
received a $370 million or 6.8% increase over the year-ago
post-sequestration funding level.
Situation Remains Bleak
Even more than three months after the Senate passed the Omnibus
Appropriations bill, the research funding scenario continues to
look bleak. Most economists are of the opinion that with cost of
research rising astronomically, this nominal revision can hardly
bring any reprieve. While the additional funding for NIH will help
sustain current projects and begin funding for new research grants,
this is still $714 million short of NIH's pre-sequestration budget.
Further, things are not at all cheery for the Centers for Medicare
and Medicaid Services (CMS). While the bill included $3.7 billion
for the CMS, this was $195 million less than what was enacted in
the previous fiscal.
Unless totally repealed or replaced, these spending cuts will last
through 2021. NIH expects sequestration to turn graver in the
coming years leading to serious consequences like delaying progress
in medical breakthroughs, deterioration in job creation and
tempering of economic growth. An NBC news article recently noted
that many new researchers, who were trained with the U.S.
taxpayers' money, may have to move to Europe and Asia where
government funding for medical research is on the rise.
Moreover, the medical device excise tax is taking a heavy toll on
the MedTech sector, hurting pricing decisions of companies and
subjecting them to tremendous margin pressure. The 2.3% excise tax
(effective Jan 2013), which is imposed on the sales price instead
of net profit, amounts to a sizable sum, wiping out almost a
quarter of the profit at the med instrument owners.
The big players are trying out ways to change their business model
and cost structure to accommodate the excise tax. These companies
are undertaking various restructuring initiatives to counter costs
incurred from the implementation of the new tax. Restructuring
especially to offset the effect of the excise tax has already been
adopted by several key players. The companies are also trying to
focus on strategic mergers and acquisitions (M&A), emerging
market expansion or are reducing operations in order to weather the
MedTech M&A continues unabated in 2014. Wary of an uncertain
economy, MedTech giants have resorted to the acquisition route to
harness their strengths and diversify offerings.
The first quarter earnings season in the medical device sector
kicked off with such a mega acquisition announcement. Last week, on
its earnings call,
) disclosed that it has entered into a definitive agreement to
acquire Biomet, Inc. -- a provider of surgical and non-surgical
products -- for a transaction value of $13.35 billion. According to
Zimmer, with the successful completion of this acquisition, it will
be better able to capture the $45 billion musculoskeletal industry.
Another noteworthy move in recent times is the colossal $13.6
billion takeover of Life Technologies Corporation by its major peer
Thermo Fisher Scientific
) which closed in February. In the same month, artificial knee and
Smith & Nephew plc
), entered into an agreement to buy
) for $1.7 billion in order to expand its product line in sports
Global orthopedic device makers,
Wright Medical Group, Inc.
) are also resorting to inorganic means to expand their businesses.
In April, Stryker acquired German surgical tools firm, Berchtold
Holding. In March, it acquired U.S.-based developer of hip
arthroscopy products, Pivot Medical. In December last year, Stryker
was in the headlines with its $1.65 billion acquisition of robotic
assisted surgery developer, MAKO Surgical Corp.
Wright Medical to expand in the fast growing extremities market,
announced a couple of acquisitions: Solana Surgical and OrthoPro.
Earlier in November, Wright Medical completing the acquisition of
French orthopedic extremities company Biotech International.
Some other significant newest buyouts include
) $860 million acquisition of Israel-based diagnostic products
maker Given Imaging (in February) and
) takeover of Solstas Lab Partners Group and its subsidiaries for
approximately $570 million (Mar 2014). Besides, to expand its
dental business in Europe, in February,
Henry Schein, Inc.
) acquired five companies from a Dutch company, Arseus NV.
There have been many more M&As in the MedTech space.
Boston Scientific Corporation
) closed the acquisition of Bard EP, the electrophysiology business
of C.R. Bard, Inc. (
). Earlier in September,
) closed its $3.9 billion deal to acquire Gambro AB, a Sweden-based
renal products company.
In the light of the discussion above, we see no slowing down of
M&A deals in the MedTech space in rest of 2014. We also expect
a significant pickup in in-licensing activities and collaborations
for the development of pipeline candidates.
With the medical device excise tax in force, leading to further
contraction in profit margins, we have been observing a lot of
divestments of late, particularly of non-core business segments.
Divestments, specifically to offset the tax, have been announced by
many key players. We expect this trend to continue in the rest of
MedTech giant Johnson & Johnson (
), after its $1 billion acquisition of privately-held,
pharmaceutical discovery and development company, Aragon
Pharmaceuticals, Inc, in Apr 2014 announced its decision to sell
off its Ortho-Clinical Diagnostics business to
The Carlyle Group
) for about $4 billion. The divestment, which is expected to go
through in mid-2014, will help the company increase its focus on
the core pharma business.
Taking a cue from
), which separated its research-based pharmaceuticals business by
creating a new company
) last year, Baxter International revealed in Mar 2014 that it will
split its biopharmaceuticals and medical device segments into two
independent companies in order to put greater management focus on
these two businesses.
In January, Wright Medical exited the hip and knee implant market
with the $290 million divestment of its OrthoRecon business to
MicroPort Scientific Corporation and its affiliates. In January
again, Covidien sold off its Confluent Surgical product line for
approximately $235 million.
) has also entered into a definitive agreement to divest its blood
transfusion diagnostics unit to Spain-based Grifols for $1.675
) on the other hand is working on a potential tax-free spin-off of
the company's health care business. In November last year, Quest
Diagnostics divested its Enterix colorectal cancer screening test
Although the U.S. still holds the leading position with almost
one-third of global market share, a gradual slowdown in established
markets due to a number of lingering headwinds are forcing MedTech
companies to look for opportunities in the developing world.
Currently, with the growth rate remaining in low single digits in
developed markets like the U.S., Europe and Japan, large-cap
medical device makers are looking to invest more in the high-growth
Accordingly, emerging economies like Brazil, Russia, India and
China (BRICs) as well as Turkey, Mexico, Malaysia, South Africa,
South Korea and the Czech Republic are fast coming up in the
medical devices space. These emerging economies are seeing an
increasing uptake in medical devices largely due to growing medical
awareness and economic prosperity.
An aging population, increasing wealth, government focus on
healthcare infrastructure and expansion of medical insurance
coverage make these markets a happy hunting ground for global
medical device players. Expansion in emerging markets, especially
those with double-digit annual growth rates, represents one of the
best potential avenues for growth in 2014 and beyond.
Among the BRIC members, Brazil is currently the largest healthcare
market in Latin America, covering almost one-fourth of the
population. Though India has one of the largest and fastest growing
healthcare markets in the world, it is considered to have the least
developed healthcare infrastructure and spends relatively little in
this area. In order to reverse the trend, during the 12th Plan
(2012-2017), the Indian government planned to spend 2.5% of its GDP
(up from 1.2% earlier) on health care and raise it to at least 3%
Accordingly, big players in the MedTech sector are vying to expand
their presence in BRIC and other emerging markets. These companies
are also looking to establish their manufacturing facilities
Abbott continues to lead the trend with about 40% of sales coming
in from the emerging markets. The company expects this contribution
to increase to 50% by 2015. Johnson & Johnson showed 13% growth
in the BRIC nations during the first quarter of 2014 and is
currently working to increase its presence in these regions.
The company has already set up manufacturing and R&D centers in
Brazil, China and India and expects to expand further in China on
the back of the Synthes acquisition.
Becton, Dickinson and Company
), with about 58% of revenues from international markets, witnessed
double-digit sales growth in emerging geographies during the first
quarter with China growing over 25% at constant exchange rate
(CER). For Medtronic, emerging market grew a robust 12% (at CER) in
its third quarter fiscal 2014, representing more than 13% of the
company's total sales mix. Management is targeting 20% of its
revenues from emerging markets, adding incremental revenues of $2.5
billion over the long term with mid-teens growth for the current
Against the backdrop of flattening or declining sales growth in
developed markets, Boston Scientific achieved 8% international
growth in the first quarter of 2014 on the back of 22% growth in
emerging markets, which represented 9% of total company sales.
Stryker, with 7% sales coming from emerging markets in the first
quarter of 2014, is expected to grow market share further in key
geographies like China and India. Orthopedic major, Smith &
Nephew, continued to gain double-digit sales growth in emerging
Thermo Fisher is also expanding its presence in emerging markets.
It expects to garner 25% of total revenues from the high-growth
Asia-Pacific region and emerging markets by 2016, up from 19% in
2011. According to the company, China with its rapid
industrialization, increasing focus on healthcare, new BioPharma
R&D centers and government sponsored research has robust growth
Zacks Industry Rank
Within the Zacks Industry classification, MedTech is broadly
grouped into the Medical sector (one of 16 Zacks sectors) and
further sub-divided into four industries at the expanded level: med
instruments, med products, med/dental-supp and medical info
We rank all the 260-plus industries in the 16 Zacks sectors based
on the earnings outlook and fundamental strength of the constituent
companies in each industry. To learn more visit:
About Zacks Industry Rank
As a guideline, the outlook for industries with Zacks Industry Rank
of #88 and lower is 'Positive,' between #89 and #176 is 'Neutral'
and #177 and higher is 'Negative.'
The Zacks Industry Rank for med instruments is #101, med products
is #161, med/dental-supp is #164, while the medical info systems is
#216. Analyzing the Zacks Industry Rank for different MedTech
segments, it is obvious that while the outlook for medical info
systems stocks is negative, that for med instruments, med products
and med/dental-supp is neutral.
Earnings Trend of the Sector
So far, 41.2% of the Medical sector participants have reported
first quarter results which have been fairly good with respect to
beat ratios (percentage of companies coming out with positive
surprises). We note that the results were not impressive in terms
of year-over-year growth.
The earnings "beat ratio" was 76.2%, while the revenue "beat ratio"
was 38.1% in the first quarter. Total earnings for the companies in
this sector increased a strong 15.2% year over year on revenue
growth of 16.2%. In fact, earnings and revenues showed a massive
improvement from the fourth quarter 2013 performance.
The earnings is expected to increase by 3.1% in the second quarter
2014. The sector is expected to register an impressive growth of
8.1% for the full-year 2014 and 16.2% in the full-year 2015. In
terms of revenue expectation, the sector is expected to register
7.3% year-over-year growth in the second quarter of the year,
resulting in an annual growth rate of 7.4%.
For more information about earnings for this sector and others,
please read our
'Earnings Trends' report
In spite of several core market challenges, the big three medical
device players -- Medtronic, Boston Scientific and St. Jude
Medical, Inc. (
) -- are striving to gain share in the ICD market through new
product launches. With gradual stability in the ICD market, these
players should be able to revive their top line. In the first
quarter of 2014, St. Jude Medical's ICD revenues increased 2.1% (3%
Although Boston Scientific posted another quarter of weak ICD sales
with 3.1% year-over-year decline, it is taking several initiatives
to revive its top line. We also wait for a better-than-expected ICD
performance from Medtronic which is slated to report its fourth
quarter and fiscal 2014 results on May 20.
The Cooper Companies Inc.
) holding a Zacks Rank #2 (Buy) represents a value proposition
based on factors such as margin expansion, acquisitions, product
line expansion and geographical reach as well as share buybacks.
Johnson & Johnson holding a Zacks Rank #2 has been trying to
offset the declining sales of some of its important products by
bringing in new products through in-licensing deals and
Beyond the MedTech majors, we are also optimistic about the Zacks
Ranked #3 orthopedic device players, Zimmer Holdings and Stryker
Corporation. The percentage of population over 65 in the U.S.,
Europe, Japan and other regions is expected to nearly double by the
year 2030. We believe the orthopedic giants stand to benefit from
this aging demography.
Among scientific instrument makers, Thermo Fisher Scientific has
been successfully expanding operating margins over the past few
quarters on the back of operational efficiency. Apart from the
newest incorporated segment Life Sciences Solution segment with the
buyout of Life Technologies, Thermo Fisher's market leading
portfolio of analytical technologies demonstrated strong
performance with growth in the Life Sciences Mass Spec and
Among other MedTech stocks,
Mead Johnson Nutrition Company
Cardinal Health, Inc.
) carrying a Zacks Rank #2 (Buy) also look attractive.
CHALLENGES AND WEAKNESSES
Coming to the weakest link in the MedTech sector, we advise
investors against names that offer little growth/opportunity over
the near term. These include companies for which estimate revision
trends for 2014 reflect a bearish sentiment.
Stocks which do not look inspiring are
) sporting a Zacks Rank #5 (Strong Sell), Wright Medical,
Patterson Companies, Inc.
DENTSPLY International Inc.
), all carrying the Zacks Rank #4 (Sell).
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