In this article, let's take a look at Covidien PLC. (COV, Financial), a $41.12 billion market cap company, that develops, makes and distributes medical devices and supplies and other health care products.
The deal
According to Bloomberg, Medtronic (MDT, Financial) agreed to buy Covidien for $42.9 billion in cash and stock as it transforms into a broader-based company bolstered by new tax advantages. Covidien's business and geographic reach, has attracted Medtronic's attention.
Medtronic will pay approximately 30% more than the company´s closing price of $72.02 in mid-June. This price reflects the firm's growth prospects that are the best in the industry. Regions such as emerging markets are also playing an important role in that growth.
Growth and market share
Covidien had to invest hard in R&D to inject life into its mature device business. The R&D budget was doubled in four years. Lot of money went to laparoscopy, energy-based devices, vascular, and gastrointestinal products. These products will offer better differentiation so it can continue gaining market share.
Principal competitors
In the medical devices business (83% of FY 13 sales), the company competes with good health care companies such as Johnson & Johnson (JNJ, Financial), C.R. Bard (BCR, Financial) and ConMed (CNMD, Financial).
In the medical supplies division (17%), Covidien competes with Becton Dickinson (BDX, Financial), 3M (MMM, Financial), Con- Med, CareFusion (CFN, Financial) and First Quality.
Strengths
The company has cost advantages due to its massive distribution infrastructure. Further, it has a relative pricing power because of its focus on value. But not all are good news, the management must have the ability to identify product lines that complement its existing portfolio, and this is not a simple task.
Moreover, macro decisions, like the one to move its corporate headquarters to Ireland, we think it was positive due to its fiscal advantages.
Revenues, margins and profitability
Looking at profitability, revenues growth by 4.26% but earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($0.67 vs $0.85). During the past fiscal year, the company increased its bottom line. It earned $3.40 versus $3.37 in the prior year. This year, Wall Street expects an improvement in earnings ($4.01 versus $3.40).
The gross profit margin is currently high at 65.07% while its net profit margin of 11.4% is similar to the industry average.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| COV | Covidien | 15.24 |
| ABT | Abbott Laboratories | 10.15 |
| MDT | Medtronic Inc. | 15.5 |
| BAX | Baxter International Inc | 22.47 |
| SYK | Stryker Corporation | 7.63 |
| Â | Industry Median | 8.17 |
The company has a current ROE of 15.24% which is higher than the industry median. Also, it is higher than the ones exhibit by Abbott (ABT, Financial) and Stryker (SYK, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So, for investors looking at those levels, Medtronic and Baxter (BAX, Financial) also could be good options. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 47.0x, trading at a discount compared to an average of 65.9x for the industry. To use another metric, its price-to-book ratio of 3.50x indicates a discount versus the industry average of 3.55x while the price-to-sales ratio of 3.50x is above the industry average of 3.19x.
As we can see in the next chart, the stock price has an upward trend in the five-year period.
The company's share price jumped more than 44% when compared to its closing price of one year ago.
Final comment
As outlined in the article, the deal would significantly expand and diversify operations, as well as expanding its geographic reach. For example, sales from the emerging markets are about $3.7 billion and are expected to be higher in the future.
The PE relative valuation and the return on equity that significantly exceeds the industry average and make me feel bullish on this stock.
Other hedge fund gurus like Louis Moore Bacon (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), Ronald Muhlenkamp (Trades, Portfolio), and the fund HOTCHKIS & WILEY added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
