Medtronic (MDT), the world’s largest medical device maker, received some important news that has been largely passed over as the market anticipated Apple (AAPL) and other headline earnings reports.  The Food and Drug Administration cleared a heart valve made by Medtronic that can be placed without open-heart surgery.  This is a first-of-a kind device and could delay a patient’s need for open-heart surgery and will likely reduce the overall number of surgeries for patients that would typically require multiple, potentially dangerous surgeries to replace heart valves.

The device, known as the Melody transcatheter pulmonary valve, is designed to be implanted into patients through a small catheter that’s inserted into the body. It replaces the pulmonary valve in patients born with a heart defect, and is the first heart valve approved for sale in the U.S. that be implanted without open-heart surgery.

“The FDA’s approval of Melody allows patients to undergo a much less invasive procedure to treat their heart condition,” said Jeffrey Shuren, the director of FDA’s devices division. The valve won’t cure a patient’s heart condition and over time will likely need to be replaced. — The Wall Street Journal 1/25/2010 (subscription required)

This particular valve will likely only be used in the treatment of about 1000 patients annually, but the introduction of this less evasive treatment has great possibilities for more pervasive heart problems.  The new device will still be subject to further testing, but for now it appears to be a breakthrough worthy of mention.  The trick would be to carry this new breakthrough over into other types of heart procedures.  Last year, Medtronic purchased a company that sells aortic valve replacement systems in Europe and will seek FDA approval soon; clearly, the aortic valve would be a much bigger seller if Medtronic could implant the device without invasive surgery. 

In addition to news of the approval, Medtronic announced it will buy one of its European competitors, Invatec for up to $500 million.  Medtronic will initially pay $350 million but it could pay an additional $150 million depending on if certain experimental devices eventually receive approval.  Invatec makes stents and balloons used to treat cardiovascular disease, and should provide another avenue for MDT to grow, particularly in Europe.

At Ockham, we continue to have a Undervalued stance on Medtronic as we believe the company’s underlying fundamentals are not being recognized by the market adequately, and as you can tell from our ratings history chart, we have felt this way for some time.  According to our methodology, both price-to-cash earnings and price-to-sales are currently well below their historically normal range for this stock.  In addition to their appealing valuation, MDT is showing some very promising growth aspects.  News like today’s approval will not likely contribute substantially to growth in the next year, but are very encouraging to long term investors because they have great potential.

On Thursday, Medtronic (MDT), which produces and sells medical devices, announced that the board has accepted a plan to raise the quarterly dividend by 9% to more than 20 cents per share.  The annual dividend now comes to 82 cents per share and at prices as of Wednesday’s close the yield is about 2.5%.  The company’s Chairman and CEO Bill Hawkins was quote as saying,

“Today’s actions demonstrate both the board of directors’ and management’s strong confidence in the long-term strength of the company’s cash-flow generation and continued commitment to returning capital to shareholders. Our on-going commitment to return a minimum of 40 to 50 percent of our free cash flow to shareholders each year allows us to offer Medtronic investors enhanced returns through dividend increases and ongoing share repurchases, while also making disciplined, strategic investments for sustainable earnings growth.”

  The company generated $3.9 billion in free cash flow for fiscal 2009, and the current dividend payments come to about 41% of that or $1.6 billion.  In addition, the company’s management sent a signal to the market that they believe the stock is simply too cheap right now, as they increased the share buyback program to some 60 million shares, or 5.4% of the total outstanding.  This is an aggressive move certainly, but one that seems reasonable based on Ockham’s rating methodology.  Currently, Medtronic receives our most bullish valuation of Greatly Undervalued because the company’s fundamentals would suggest a much higher price.  For example, over the past ten years the market has been willing to pay between 17.2x and 24.3x cash earnings but the current price-to-cash earnings is much lower at 10.7x.  Similarly price-to-sales has normally ranged between 4.2x and 5.9x, but the current metric is 2.3x.  In order for Medtronic to trade back on the low end of its price-to-cash earnings and price-to-sales, given current fundamentals, the stock would trade at around $52!

As you can see from our historical valuation chart, we have been positive on this stock for some time, but as of yet the market has not responded to the apparent value present in Medtronic.  Today’s actions may be enough to spark a little more interest, but as of mid day the shares are trading up only a little more than 2%.

One other thing to take note of is a developing story being reported by the Wall Street Journal.  The article alludes to a former Army surgeon who has been hired as a consultant for Medtronic, and was paid handsomely for his services.  However, a study that he headed has been rejected as it was based on falsified information to the benefit of Medtronic.  The details are still being sourced but Medtronic claims the study was independent of his consulting services and was in no way influenced by Medtronic.  The truth will come out in time, but at this point nothing is explicitly clear about how this will effect Medtronic stock.  The timing of this announcement by Medtronic is interesting though as the share buyback and dividend increase coincides with the same day that the reported conflict of interest is brought to the public.

Medtronic (MDT) reported its fiscal fourth quarter (ended April 25) results prior to trading Tuesday morning. The medical device company reported flat net income from results a year ago that were aided by a tax gain. However, revenues rose by more than 18%, thanks in large part to the introduction of the Endeavor drug-dispensing stent. The company is also benefiting from the acquisition of Kyphon, which has added value to the spinal segment of the business. The company earned 72 cents per share compared to 70 last year, and without the acquisition and restructuring charges the results would have improved to 78 cents per share in the quarter. The company projected fiscal 2009 earnings to be $2.94 to $3.02, and revenues of $15 - $15.5 billion.

The early success of Endeavor is a very positive sign for a company that has been fully engaged with restructuring and cost cutting struggles. The successful launch of Endeavor has boosted sales for the cardiovascular business unit by 22% and Medtronic now has more than 20% market share in that industry segment . The cardiac-rhythm-disease management segment–the company’s largest business–experienced a revenue increase of 5.6%. Earlier in May, Medtronic stated that it will reduce headcount by 2.8% in low growth segments of the business but the job cuts will be partially offset by hiring in higher growth segments. Also, just last week the company made public the departure of Chief Operating Officer Michael F. DeMane.

Currently, our research is positive on the long-term prospects for Medtronic. The stock is up about 2% since the announcement but it is still selling at an attractive price level. The current price-to-cash flow is a full 42% below the average of its historic norm. Likewise, price-to-sales is 39% below where we would expect it to be. The successful launch of Endeavor should continue the positive trend of healthy sales growth. Given these factors—in order for MDT to trade within what we consider normal ranges—the stock would need to trade in the range of $69 - $81. The headache’s caused by recent cost cutting and restructuring should be coming to a close. Thus, we think there is sufficient reason for long- term investors to look closely at Medtronic.