When investors think about healthcare stocks, growth is often the first word that pops into their minds. This happens with good reason, as health care issues are often quintessential growth stocks. By growth stock we mean the shares of a company with earnings that are increasing at a higher rate than its peers. In general, growth investors focus on the denominator in the price-to-earnings (P/E) ratio, looking for companies or industries where high expected earnings growth would propel stock prices upward. Such issues typically do not offer robust dividend yields, as company managers usually prefer to reinvest profits in the business in order to take advantage of high returns on capital and support bottom-line growth, rather than distribute a portion of net income to shareholders in the form of dividends.
That said, there are healthcare companies that pay dividends, a number of which are quite generous. To find some of these issues, we screened the Drug, Medical Supply Invasive and Non-Invasive, Medical Services, Pharmacy Services, and Biotechnology industries. First, we looked for companies with dividend yields above 1% and, then, to help ensure the dividends were sustainable, we limited the results to those firms with long-term debt as a percentage of total capital below 50%. The list contained 38 names, we highlighted two with appealing investment merit: Covidien Plc (COV) and Medtronic, Inc. (MDT).
Covidien is a worldwide developer, manufacturer, and distributor of healthcare products used in clinical and home settings. Its wares are present in the majority of America’s hospitals and include:
Medical Devices (68% of sales) - endomechanical instruments, energy devices, soft tissue repair products, vascular solutions, oximetry and monitoring devices, and airway and ventilation products
Pharmaceuticals (17% of sales) - specialty pharmaceuticals, active pharmaceutical ingredients, contrast products, and radiopharmaceuticals
Medical Supplies (15% of sales) - nursing care items, medical surgical devices, SharpSafety products, and OEM solutions
Furthermore, it has a growing presence in non-U.S. markets, with 45% of fiscal 2011 sales (year ended September 30th) being derived from foreign sources. Covidien markets to physicians, nurses, materials managers, group purchase organizations, and governmental healthcare authorities through a direct sales force as well as third-party distributors. The company’s research and development expenditure last fiscal year amounted to 4.8% of companywide sales.
The near-term outlook appears to be positive for Covidien. The Medical Devices unit is the company’s primary breadwinner and continues to perform admirably. That division posted a high single-digit top-line increase during this year’s fiscal second quarter. Although challenges in Europe persist, we remain cautiously optimistic that strength in North America and emerging markets will help counteract this situation. Hence, we look for strong earnings growth ahead, reflecting healthy improvements in revenues.
Recent and upcoming product introductions should help sustain the strong sales growth rate. One promising example is the OneShot Renal Denervation System, a balloon catheter that’s used for treatment-resistant hypertension. Given the company’s aggressive spending on research and development, we look for further additions to the lineup in the coming months.
What’s more, the company has recently been active on the acquisition trail. Its most recent purchase was Newport Medical for $108 million, and it intends to acquire Oridion Systems, another medical device company, for around $300 million. Also worth noting, Covidien plans to spinoff its Pharmaceuticals business within the next 18 months.
There is reason for optimism for the 3- to 5-year pull, as well. Covidien recently signed a five-year agreement to collaborate with GE Healthcare, whereby the latter company will utilize COV’s technologies in some of its patient monitors.
These shares offer a 1.75% dividend yield, which is decent relative to those of other healthcare stocks under our coverage.
Medtronic is the world’s largest manufacturer of implantable biomedical devices with sales to more than 120 countries. Cardiac and Vascular products accounted for 52% of fiscal 2011 (fiscal years end Friday closest to April 30th of following calendar year) revenues and include: defibrillation systems, pacing systems, cardiac rhythm disease management, coronary, structural heart, endovascular and peripheral, and cardiovascular devices. The Restorative Therapies group makes up the remaining 48% of revenues and its products include: core spinal, biologics, spinal, neuromodulation, diabetes, and surgical technologies. Nearly 45% of 2011 sales were to overseas customers. Research and development cost amounted to 9.2% of revenues and has stayed fairly consistent over the past several years.
Medtronic might well continue to face challenges in the short term. The healthcare environment remains quite volatile, partly because of lower hospital utilization trends. Although economic growth has been on a gradual incline, high levels of unemployment and reduced medical insurance coverage continues to deter patient admissions. More specifically, weakness at the Cardiac Rhythm Management, Cardiology, and Spine units has been offsetting gains in other segments, such as Neuromodulation. That said, we think the first two segments may have hit a bottom, but prospects for the Spinal division remain ambiguous.
Looking at the longer term, Medtronic has several growth catalysts. A deep product pipeline reflects healthy investments in research and development. Recently, the company introduced several offerings, such as the Valiant stent and the POWEREASE system, a group of electronic instruments intended for use in spinal surgeries. What’s more, a myriad of clinical trials are currently underway, which increases the likelihood of further product approvals.
We look for the company to scan the market for accretive acquisitions over the 3- to 5-years ahead, given its healthy balance sheet and sizable cash base. Funds will also likely be plowed back into existing operations in order to fuel growth moving forward. Medtronic stock holds a favorable rank for Safety and further dividend hikes (current yield is 2.87%) seem likely given past increases.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.