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MedTech Industry Stock Update - Sept 2013 - Zacks Analyst Interviews
9/10/2013 3:29:00 AM
As expected, the Patient Protection and Affordable Care Act (PPACA), particularly the medical device excise tax, has taken a heavy toll on the MedTech sector, hurting pricing decisions of the companies and subjecting them to tremendous margin pressure.
The small and the medium-sized players in the sector (comprising
about 80% of the industry) are the worst hit by this public policy.
The 2.3% excise tax (effective Jan 2013), which is imposed on the
sale price instead of net profit, amounts to a material burden,
wiping out almost a quarter's profit at many industry players.
Restructuring, especially to offset the effect of tax, has
already been adopted by key players such as
St. Jude Medical, Inc.
). 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 tax burden.
The most noteworthy move is observed in MedTech giant
) strategic shift from being a device manufacturer to a provider of
broader healthcare services and solutions with meaningful clinical
and economic value for hospitals, physicians, patients and payers.
As an opening move, on Aug 12, 2013, the company acquired privately
held Cardiocom, a provider of integrated telehealth and patient
services for chronic disease management for a total consideration
of $200 million.
In May, the company acquired the toxicology and clinical
laboratory business from Concentra, a subsidiary of
). Earlier, in January, the company had acquired the clinical and
anatomic-pathology outreach laboratory businesses of
Massachusetts-based UMass Memorial Medical Center. According to the
company, this will help boost its long-term growth opportunities in
the faster-growing esoteric markets.
Earlier, in Dec 2012, the company divested its OralDNA Labs
salivary-diagnostics business in order to redirect its resources to
core diagnostic information services. Johnson & Johnson is also
currently looking for opportunities to sell or spin off its Ortho
Clinical Diagnostics business.
In June, the company acquired a South Korea-based distributor,
Life Science Korea, which is in line with its 'go direct' strategy
in this country. In April, as a part of this strategy, Life
Technologies acquired KDR Biotech Co., a reagents distributor based
in Seoul, Korea. In China, on the other hand, the company came up
with a licensing agreement with Suzhou Ribo Life Sciences Co. Ltd.
in Jun 2013.
On the other hand, key growth drivers in India include
outsourcing of clinical packaging and logistics by Pharma and
Biotech companies, growing Biotech and food & beverage
industries, and introduction of environmental regulations to
address air quality issues in the wake of rapid industrialization.
After acquiring China Kanghui Holdings, which added strength to
its orthopedic franchise in that country, Medtronic is keeping an
eye on other accretive buyouts in the region. According to the
company, the premium segments in China and India alone include a
population of more than 380 million, leading to $5 billion of
annual sales opportunity for Medtronic.
PCE has been associated with the company for the last 30 years and has distributed its sports medicine, orthopedic reconstruction and trauma offerings in Brazil. In May 2013, the company announced another agreement to take over Adler Mediequip Private Limited and with it, the brands and assets of Sushrut Surgicals Private Limited, a leader in mid-tier, orthopedic trauma products for the Indian market.
Johnson & Johnson has already set up manufacturing and R&D centers in Brazil, China and India. The Guangzhou Bioseal Biotech deal marked the company's first MedTech acquisition in China. The company is expected to expand further in China on the back of the Synthes acquisition.
Other Issues at Work
Apart from the medical device excise tax, the MedTech industry is currently plagued by several issues, including pricing concerns, hospital admission and procedural volume pressure, Medicare reimbursement issues and regulatory overhang. While the debt crisis in Europe remains unresolved, economies throughout the world are trying to come to terms with myriad challenges. Consequently, procedural volumes in the U.S. have been hit by a high unemployment rate, which has resulted in the expiry of health insurance as well as a decline in enrollment in private health plans.
Governments across several European countries have taken up measures to curb spending on devices, which is taking a toll on utilization. Volume headwind is likely to linger as unemployment continues to influence procedure deferrals.
Last but not least, the highly regulated U.S. medical device industry is constrained by stringent and complex procedures, leading to approval delays. This sometimes demotivates companies, deterring them from investing in product development. According to a report based on a survey of over 200 medical technology companies (FDA Impact on U.S. Medical Technology Innovation), the U.S. FDA takes a significantly longer time to review compared to its European counterpart.
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 systems.
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 #189, med products is #104, med/dental-supp is #118, while the medical info systems is #162. Analyzing the Zacks Industry Rank for different MedTech segments, it is obvious that while the outlook for med instruments stocks is negative, that for med products, med/dental-supp and medical info systems is neutral.
Earnings Trend of the Sector
So far, 100% of the Medical sector participants have reported second-quarter results, which have been fairly good with respect to beat ratios (percentage of companies coming out with positive surprises). However, the results were not impressive in terms of year-over-year growth.
The earnings "beat ratio" was 70.0%, while the revenue "beat ratio" was 48.0% in the second quarter. Total earnings for the companies in this sector declined 1.1% year over year despite marginal revenue growth of 2.4%. In fact, earnings and revenues showed a sharp decline from the first quarter 2013 growth of 4.5% and 8.1% respectively.
The earnings is expected to decline by 4.3% in the third quarter 2013 although it will increase by 1.1% in the subsequent quarter. However, the sector is expected to register a nominal growth of 0.5% for the full-year 2013. In terms of revenue expectation, the sector is expected to register 4.1% and 2.4% year-over-year growth in the third and fourth quarters of the year respectively, resulting in an annual growth rate of 2.8%.
Medical device majors like Boston Scientific and St. Jude Medical are confronted with challenging economic conditions, a competitive environment, pressure on core segments and a larger-than-expected currency headwind. Although they managed to stay ahead of the Zacks Consensus Estimate for earnings and revenues in the second quarter, challenges continue to remain in the core stent and defibrillators businesses.
On the other hand, Medtronic barley managed to stay in line with the Zacks Consensus Estimate for earnings. While we are to some extent relieved with the signs of stability in Medtronic's core CRDM and pacing segments, challenges still remain in the Spine business, which is expected to remain sluggish, thereby affecting the company's overall performance.
Other adverse earnings reports from major industry players include the second quarter earnings miss of Intuitive Surgical ( ISRG ) due to a stiff capital spending environment and sluggish benign gynecologic procedures in the U.S. We witnessed a negative earnings surprise from Quest Diagnostics. We believe that the overall soft industry trends leading to a challenging volume environment for testing laboratories and utilization weaknesses are looming headwinds for Quest.
On the positive, earnings beat from big names like Johnson & Johnson, Laboratory Corporation of America Holdings ( LH ), Zimmer Holdings, Thermo Fisher, Life Technologies, Edwards Lifescience and Abbott Labs kept the hope alive.
In spite of several core market challenges, the big two medical device players -- Medtronic and Boston Scientific -- are striving to gain share in the ICD market through several new product launches. They are also exploring new avenues of growth beyond the mature pacemaker and ICD markets. With gradual stability in the ICD market, they should be able to revive their top line. Also, better pipeline visibility and appropriate utilization of cash should increase confidence in the medical device sector.
Microarray product maker Affymetrix Inc. ( AFFX ) was languishing with its flagship GeneChip Expression products until management found a strategy to expand into high-growth markets for translational medicine, molecular diagnostics and applied markets. Consequently the shares of Affymetrix hit a 52-week high accompanied by a bullish Zacks Rank #1 (Strong Buy).
Zacks Rank #2 (Buy) stocks in the MedTech sector include The Cooper Companies Inc. ( COO ) and Boston Scientific among others. Cooper represents a value proposition based on factors such as margin expansion, acquisitions, product line expansion and geographical reach as well as share buybacks. On the other hand, we are positive about multiple initiatives taken by Boston Scientific to expand electrophysiology (EP) division.
Zacks Ranked #3 St. Jude is also doing well with its growing Atrial Fibrillation products portfolio that witnessed a major boost with the acquisition of Endosense and regulatory approval for its Mediguide catheters.
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. In the U.S., the oldest baby boomers are now approaching retirement age. 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. Thermo Fisher's market leading portfolio of analytical technologies and specialty diagnostic will be complemented by the upcoming buyout of Life Technologies. The latter has an expansive line of consumables for genomic, molecular and cell biology.
Among mid-cap MedTech stocks, Align Technology ( ALGN ) and AmSurg Corp. ( AMSG ) carrying a Zacks Rank #2 (Buy) 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 2013 and 2014 reflect a bearish sentiment.
After posting dismal second quarter results and lowering its fiscal guidance, Intuitive Surgical ( ISRG ) currently retains a Zacks Rank #4 (Sell). Other Zacks Rank #4 (Sell) stocks which do not look inspiring are Allscripts Healthcare Solutions, Inc. ( MDRX ), Symmetry Medical, Inc. ( SMA ) and Merge Healthcare Inc. ( MRGE ).
Pricing compression on hips, knees and spine products, which impaired the performances of several orthopedic companies, remains a key concern, at the macro level. We remain skeptical about companies including Wright Medical Group ( WMGI ), which currently carries a Zacks Rank #4 (Sell).
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