I love Barron’s. I really do. I read it from cover to cover, and I truly believe it is one of the few business publications that knows the difference between a good company and a good stock. Now that I’ve sugared it up, let me tell you this: its article on Medtronic is wrong! Here are some arguments the Barron’s article made that require my rebuttal:
“The stock looks cheap, trading at about 8.2 times expected forward earnings, but the company’s 10% long-term-earnings growth rate is below the industry average…
At 8.2 times earnings, the market prices in zero growth. If any growth is produced, even half of its “below-industry-average” growth, the stock will not be trading at 8.2 times earnings, but at a much higher valuation. Ironically, today’s low valuation gives MDT earnings a yield of 12%. If MDT remains at this valuation for a long time, it can buy back 12% of the company year after year, and this in itself would result in 12% earnings growth.
“… and it carries a fair amount of debt….
The amount of debt seems high at first, at $10.5 billion; but the company has $3.9 billion in cash and short-term investments, thus net debt is closer to $6.6 billion. MDT generates $3.4 billion of free cash flows – it can pay off ALL of its net debt in less than two years. Also, don’t confuse MDT with low-quality, highly cyclical stocks that were in vogue in the first half of 2010. This is a company that maintained a return on capital of over 20% for decades – an indication of a significant moat. Its revenues are extremely predictable, cash flows are very stable, and thus debt levels are very reasonable. Medtronic’s stock was punished with a 10% decline for lowering its guidance by an astonishingly minor 2%.
“The stock is also a historical underperformer, turning in losses year-to-date, as well as in the last one-, two-, and five-year periods that are greater than its peers in the Dow Jones U.S. Medical Equipment Index and the overall market….
This argument fails to draw a distinction between fundamental performance and stock performance. Over the last ten years, MDT grew both sales and earnings per share at 14% a year. It increased dividends 17% a year. These are not the vital signs of an “underperformer.” As the article pointed out, MDT’s stock has gone nowhere over the past decade – that is true, but not because MDT was mismanaged or failed to grow, but rather because at the turn of the last century MDT was trading at almost 50 times earnings. Medtronic is a typical sideways-market stock: it was severely overvalued at the end of the secular bull market, thus its earnings and cash flows grew while P/Es contracted. This happened to a battalion of stocks, from Wal-Mart to J&J to Pepsico. In fact when I hear the statement that a stock has “not gone anywhere,” I immediately start looking at the stock to see if it is a buy.
“Nor do there seem to be any new products in Medtronic’s pipeline that will reach the market in time to reverse the company’s near-term lackluster sales.”
I was surprised to read this because Barron’s is usually one of the few investment publications that has a time horizon beyond “near-term.” Over the last several decades MDT has demonstrated its ability to innovate and come up with viable new products. Will that happen again “near-term”? Don’t know. Longer-term? Likely.
The Barron’s article painted Medtronic as a bad company and a bad stock. It is neither.
My firm has a position in MDT.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007). To receive Vitaliy’s future articles by email, click here.