Medical device major Medtronic Inc. (MDT) is scheduled to report its second-quarter fiscal 2015 earnings before the opening bell on Nov 18. Medtronic had posted better-than-expected results for fiscal first-quarter 2015, beating the Zacks Consensus Estimate on both lines.
However, the company’s plan to go ahead with the impending acquisition of its Irish rival Covidien plc (COV), despite the recent anti-tax-inversion measurement taken by the Obama government, has created some confusion among investors.
Last quarter, Medtronic had posted a positive earnings surprise of 1.09% while the four-quarter trailing average beat is pegged at 0.55%. Let’s see how things are shaping up for this announcement.
Factors to Consider this Quarter
Shortly after announcing its $43 billion Covidien deal, Medtronic reported first-quarter fiscal 2015 adjusted earnings per share (EPS) of 93 cents, up 5.7% year over year, and also ahead of the Zacks Consensus Estimate by a penny. Revenues came in at $4.273 billion, up 4.7% at CER, marginally ahead of the Zacks Consensus Estimate of $4.249 billion.
We take note that, in order to offset the impact of a high U.S. corporate tax rate (35%), in Jun 2014, Medtronic had announced its Covidien acquisition plans, to shift its tax base (termed as ‘inversion’) to Ireland (a mere 12.5% tax rate). However, in September, the Treasury Department announced its first steps to curb tax benefits being availed through corporate inversions, underlining a set of new rules effective immediately.
Companies like Medtronic have been hard-hit by this tax reform as the new rules will not allow them to take necessary measures to evade the U.S. tax burden, even while they access their foreign subsidiary’s earnings with the help of techniques like hopscotch loans.
However, while many pharma and Medtech majors are cancelling their offshore deals following this new rule, Medtronic’s decision to continue with the same is commendable. We believe this decision reflects Medtronic’s confidence in successful integration and high growth synergy from the impending Covidien acquisition.
However, Medtronic revealed a new financing plan post the announcement of the tax reform. Per the new strategy, it will no longer utilize cash from its foreign subsidiaries, as previously planned, but will use an external debt of $16 billion to finance part of the Covidien acquisition deal.
Yet we believe, with the Republicans grabbing the U.S. Senate over the Democrats, the whole scenario may turn in favor of Medtronic. We are looking forward to the Republicans who will likely revoke the tax levied.
Why a Likely Positive Surprise?
Our proven model shows that Medtronic is likely to beat earnings because it has the right combination of two key ingredients.
Positive Zacks ESP: Earnings ESP, which represents the difference between the Most Accurate estimate and the Zacks Consensus Estimate, is 1.04% since the Most Accurate estimate stands at 97 cents while the Zacks Consensus Estimate is pegged at 96 cents. This is very meaningful and a leading indicator of a likely positive earnings surprise for shares.
Zacks Rank: Medtronic has a Zacks Rank 3 (Hold). Note that stocks with a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 have a significantly higher chance of beating earnings. Conversely, the Sell-rated stocks (#4 and 5) should never be considered going into an earnings announcement.
The combination of Medtronic’s Zacks Rank #2 and +1.04% ESP makes us confident of a positive earnings beat on Nov 18.
Other Stocks to Consider
Here are three companies you may want to consider as our model shows these have the right combination of elements to post an earnings beat this quarter:
Williams-Sonoma Inc. (WSM) has an earnings ESP of +1.59% and a Zacks Rank #3. Williams-Sonoma will report third-quarter earnings on Nov 19.
Ross Stores Inc. (ROST) has an earnings ESP of +1.15% and a Zacks Rank #2 (Buy). Ross is expected to report its third-quarter earnings on Nov 20.
The Kroger Co. (KR) has an earnings ESP of +3.28% and a Zacks Rank #2. Kroger is expected to report its second-quarter fiscal 2015 earnings on Dec 4.
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