Medtronic (MDT): Growing by Subtraction

We may not yet have seen the bottom in the stock market, but there are still opportunities at these levels to buy stocks that are available at big discounts to where they were trading a year or so ago. As I have said in the past, history suggests that the Fed’s reliance on backward-looking data will cause them to reverse policy a little late this time, just as it did when they started to tighten. As that becomes clear, we may yet see another leg down, but even if there is a recession, it will probably be fairly mild, and stocks that already down by percentages typical of a recessionary environment are worth looking at. They have the worst priced in and if there is anything to be positive about, have limited downside and big upside.

Medical device maker Medtronic PLC (MDT) is one to consider on that basis. The stock is down 33% from its levels a year ago but is rallying this morning following some news that may at first seem to have at best mixed implications.

MDT is trading higher in this morning’s premarket after they announced that they would be spinning off two businesses, patient monitoring and respiratory interventions. The market clearly thinks this is a good move and that Medtronic needed to shrink in order to grow. The optimal size and level of diversity of corporations is an argument that has probably been around as long as there have been corporations. Should they be involved in multiple areas of business so as to smooth out bumps in any one sector, or should they be focused on doing less things but doing them better? There are strong arguments on both sides of that debate, but it usually comes down to a company’s individual situation, and that is definitely true when it comes to Medtronic.

They grew to the point where they lost focus, something which became obvious this year as supply chain issues hit them hard. Centralized supply of raw materials has its advantages in terms of purchasing power and clout, but when things go wrong it is better to be small and nimble. Things have definitely gone wrong for Medtronic in that regard this year, but their core business is still in good shape.

The selloff in the stock has been more about an adjustment to lower growth and lower margins than it has been about any major collapse. Medtronic is still very profitable, has a solid balance sheet, and generated $4.2 billion in free cash flow last year, with a 19.5% operating margin. That is all solid stuff, but a year ago, MDT was priced as if continued massive growth was an inevitability. When the supply problems called that into question, something had to give.

To be fair to Medtronic’s management team, they saw the problem quite early and took decisive action. This morning’s news that they are spinning off two underperforming business units is a continuation of that, and it will leave the company leaner and more efficient. That will be a big advantage when things turn around on the supply front, something that market forces make inevitable at some point.

Medtronic did get a bit bloated as it grew, and some adjustments had to be made. Global supply chain problems forced the timing of that, which is not ideal, but the rationalization that they have undergone this year will leave them ideally placed to benefit from when things improve. So, with all the bad news looking priced in at these levels, MDT looks like a buy even if, like me, you are skeptical of the overall stock market rally.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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