The prospects of the medical devices industry have improved following a Republican victory in the midterm elections. While merger & acquisition activities are scaling a seven-year high, the U.S. government’s crackdown on tax-dodging transactions spells trouble for the medical devices equity market worldwide. The sector’s fortunes now depend on the fate of the medical devices tax and opportunities in emerging markets.
Medical Devices Tax to Be Repealed?
The controversial 2.3% medical device excise tax has taken a heavy toll on the sector, hurting pricing decisions of companies and subjecting them to tremendous margin pressure. This tax is imposed on the sales price instead of net profit. This amounts to a sizable sum, wiping out almost a quarter of the profit of medical devices producers.
Following the midterm results, the Republicans are in a position to repeal this tax as well. According to a Reuters article, Bernstein Research noted that this repeal could boost the medical device companies’ profits by 1–5% annually. It has also named Medtronic Inc. (MDT) and Johnson & Johnson (JNJ), among others as possible beneficiaries of this repeal.
Rush for Divestments
The sector has also witnessed a slew of divestments, particularly of non-core business segments. Divestments, specifically to offset the tax, have been announced by many key players. This trend is expected to continue going forward.
For instance, in November, Smith & Nephew announced the sale of certain assets of its Advanced Wound Management division to SWM International (SWM). As part of the transaction, SWM will acquire Smith & Nephew's Gilberdyke, UK facility, which will become part of DelStar's operations (a division of SWM International).
Lure of Emerging Markets
Although the U.S. still holds the leading position with almost one-third of global market share, a gradual slowdown in mature markets due to a number of lingering headwinds are forcing companies to look for opportunities in the developing world. A growth rate in the low-single digits in developed markets of the U.S., Europe and Japan is forcing large-cap medical device makers to invest in the high-growth emerging regions.
Abbott Laboratories (ABT) continues to lead the trend with about 50% of sales coming in from emerging markets. These sales increased 13.8% year over year on a reported basis during third quarter 2014. The company’s growth strategy includes building leadership positions in key emerging geographies across its wide portfolio. For Medtronic, emerging market sales grew a robust 12% (at CER) in its second quarter of fiscal 2015. This represents more than 13% of the company’s total sales mix.
Stocks that Surged
Late last month, Medical Device and Diagnostic Industry (MDDI) magazine released a list of the top 40 medical devices companies. These manufacturers were ranked according to total revenue as of Oct 9, 2014. Given below are the top 10 companies from the list:
|
Rank |
Company Name |
Total Revenue |
Market Capitalization |
|
1 |
Johnson & Johnson |
$28.7 billion |
$294.2 billion |
|
2 |
General Electric Co. |
$18.1 billion |
$243.6 billion |
|
3 |
Medtronic Inc. |
$17.1 billion |
$61.2 billion |
|
4 |
Siemens AG |
$17.0 billion |
$92.2 billion |
|
5 |
Baxter International Inc. |
$16.4 billion |
$38.7 billion |
|
6 |
Fresenius Medical Care AG & Co. KGAA |
$15.2 billion |
$21.1 billion |
|
7 |
Koninklijke Philips NV |
$11.8 billion |
$26.1 billion |
|
8 |
Cardinal Health Inc. |
$11.0 billion |
$25.1 billion |
|
9 |
Novartis AG |
$10.7 billion |
$227.5 billion |
|
10 |
Covidien plc |
$10.4 billion |
$40.1 billion |
Below we present three U.S. stocks from the list of 40 that have the highest year-to-date returns.
Edwards Lifesciences Corp. (EW) deals in products and technologies aimed at treating advanced cardiovascular diseases, especially structural heart disease in critically ill patients. The company is the world’s leading manufacturer of tissue heart valves and repair products used to replace or repair a patient's diseased or defective heart valve.
Edwards Lifesciences holds a Zacks Rank #2 (Buy) and has expected earnings growth of 7.9%. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 37.14. The stock has gained 90.8% year-to-date and is ranked 37th on the MDDI list.
Allergan Inc. (AGN) operates through two business segments: Specialty pharmaceuticals and medical devices. The specialty pharmaceuticals segment includes ophthalmic, skin care as well as other prescription and over-the-counter dermatological products, Botox and urologics products. The medical devices segment includes breast implantation and dermal fillers.
Apart from a Zacks Rank #2 (Buy), the company has expected earnings growth of 31.8%. It has a P/E (F1) of 33.24x. Advanced Semiconductor Engineering has gained 85.2% year-to-date and is ranked 15th on the MDDI list.
CareFusion Corp. (CFN) offers products in the areas of medication management, infection prevention, operating room effectiveness, respiratory care and surveillance and analytics. These products help hospitals improve the safety and quality of care. CareFusion manages the clinical and medical products businesses of Cardinal Health, Inc. (CAH).
CareFusion holds a Zacks Rank #3 (Hold) and has expected earnings growth of 21.3%. It has a P/E (F1) of 20.49x. CareFusion has gained 47.3% year-to-date and is ranked 23rd on the MDDI list.
Given the possible repeal of the medical devices tax and increasing opportunities in emerging markets, the U.S. medical devices sector is set for a better 2015. This makes it an attractive proposition for investors looking for solid investments in the near future.
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