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Adding St. Jude Medical to Secular Trends Model; Simply the Best In Class Device Firm (STJ)

Posted on | July 13, 2009 Time: 9:58 am |

heart2In many ways, today’s action of adding St. Jude Medical (STJ) to the Secular Trends Portfolio is the culmination of a multi-year stock crush on my part. I have been following the company since before the wave of product recalls put a big bruise on the cardiac rhythm management (CRM) space as a whole. These events directly affected competitors like Medtronic (MDT) and Boston Scientific (BSX), but St. Jude avoided the issues, which served to clue me in on what is likely the best competitive advantage of the company - stellar management.

While Medtronic became bloated and lost its focus, and while Boston Scientific went out and made easily one of the worst acquisitions in sector history (the $12b Guidant purchase), St. Jude was happy to stay small and execute the pants off the other two. As a result, comparing the fundamentals of the three companies is a joke; there’s just no comparison. St. Jude wins out on margins, sales growth, earnings growth, and debt/equity ratio.

Sales & Business Segment Breakdown

St. Jude’s largest business is implantable cardiac defibrillators (ICM). Of the company’s $1.134 Billion in Q1 sales (up 17% YoY on a constant currency basis), $676 million was related to ICM and the CRM business. Atrial Fibrillation (AF) sales added another $145 million, up 27% YoY in constant currencies. Cardiovascular products (heart valves, vascular closure products ) came in with $240 million, up 21% ex-FX. The final business segment deals with neuromodulation, a growing space involving spinal cord and brain stimulation. Sales here were $73 million, up over 40% YoY.

Exchange Rate Will Boost Q2 Earnings

St. Jude earns just below 50% of revenues overseas, with most of that coming from Europe and Japan. In Q1 the rising dollar impacted sales by $51 million, but a good $30-$40 million of this impact should be ameliorated in Q2. I also think the falling dollar trend is one to invest based upon, so I see company guidance improving as mgt. builds around the lower dollar versus the Yen and Euro.

St. Jude reports next week (7/22) and I really wanted to add shares to the model in advance of what I see as strong report, one that may highlight the company’s technological lead and bring back the share premium they had over MDT and BSX for the past few years.

Tie This Thesis Up with a Pretty Bow - Or a Shiny Heart Valve

I don’t need to spell out for you how powerful the demographics are for cardiac devices. Let’s just assume that the corporate horse that runs best in this race will see its share price do very, very, well in the next 10 years. I think St. Jude is the horse to bet on. What they’ve been able to accomplish in barely 12 years is astonishing; not only is management top-notch, they are investing 12% of net sales in R&D (which they realize is essential to growth), SG&A has risen less than 230 basis points in the past 5 years (while sales have shot up 50%), and they are consistently stealing market share from larger competitors.

The market share gains are actually larger than even the numbers show; you see, the replacement rate for STJ products is far below the 30% industry average. This means that what has been a headwind created by the company’s youth (and superior quality) will become a tailwind as older devices need replacements in the future.

In terms of the all-important EPS, the company’s paltry debt load allows all these share gains and fat margins (74% gross) to drop nicely to the bottom lines of the earnings statement. Based on confirmed EPS guidance for the year of $2.48-$2.54, STJ shares trade for a run-rate P/E of less than 16x. While its peers and the broad market as a whole have fungible EPS numbers at best, STJ will likely clock 100% EPS growth over 2008 (a low year) and also 22% annualized over the 2007 levels.

A Word on The Healthcare Landscape

As I mentioned in a previous post on the pending reform climate, I see real changes coming to healthcare, regardless if something passes this year or not. I’ve expressed my desire to avoid “Big Pharma” and get into diagnostics and generics. I was initially wary of a device company simply because anyone with fat margins could be at risk in a world where the government has gone “I Spy” on profits. But the newly-commissioned studies that will be comparing various theraputic solutions to heart disease should prove the longer-term cost effectiveness of STJ products over both bypass surgeries (a blatant effect of non-preventative measures) and drugs that simply delay the inevitable.

But this is a very fluid and complex topic, so I’ll be watching the landscape closely to see if this part of the thesis holds up in 2-3 years. Secular Trends, people. Find the waves and ride the fattest one the beach has to offer..and if the weather gets bad, pick up your board and search for the next one. It’s a big ocean out there.

Adding 1200 shares STJ at $39.18

Ryan Barnes

disclosure: author does not hold a position in the companies mentioned. STJ shares held in the Secular Trends Model Portfolio

More on this topic (What's this?)
St. Jude: Unlikely to Keep Flatlining (AB Analytical Services, 10/3/09)
(STJ) St. Jude Medical Receives Trifecta Valve Approval (Stock Blog Hub, 3/4/10)
(STJ) St. Jude Medical Gets Defibrillator Approval (Stock Blog Hub, 2/12/10)
Read more on St. Jude Medical at Wikinvest
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