Published by Bob Ciura on October 26th, 2017
Every year, we review each of the 51 Dividend Aristocrats, a group of companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
The next Dividend Aristocrat in the series, is healthcare giant Medtronic (MDT).
Medtronic has an impressive history of dividend growth. The company has increased its dividend for 40 years in a row.
Plus, Medtronic typically raises its dividend at a high rate each year.
Over the course of its four-decade long dividend growth streak, the company has raised its dividend by 18% each year, on average.
We believe Medtronic has all the makings of a high-quality dividend growth stock and long term holding.
Business Overview
Medtronic was founded in 1949 as a medical equipment repair shop by Earl Bakken and his brother-in-law, Palmer Hermundslie.
Today, Medtronic is one of the largest healthcare companies in the world. It has a market capitalization of $107 billion.
The company has over 90,000 employees, and operates in 160 countries around the world. It generates annual sales of nearly $30 billion, with a large international presence.
Source: 2017 Bernstein Strategic Decisions Conference, page 4
Medtronic manufactures and sells medical devices. It operates in four segments, which are cardiac and vascular, restorative therapies, minimally invasive therapies, and diabetes.
The cardiac and vascular segment is the company’s largest, representing approximately 35% of annual sales. The four operating segments each manufacture medical devices to serve a different market.
Medtronic performed well in fiscal 2017, with 5% organic revenue growth for the full fiscal year. Adjusted earnings-per-share increased 11%, to $4.60.
All four of Medtronic’s businesses generated growth, led by 4% organic growth in the Minimally Invasive Therapies Group and Diabetes Group.
Medtronic recently reported fiscal 2018 first-quarter results. Currency-neutral revenue increased 4% year-over-year. Adjusted earnings-per-share increased 11%, and there is plenty of growth potential for Medtronic moving forward.
Growth Prospects
Medtronic is investing in growth, both organically and through acquisitions. Overall, management expectations are for
The first catalyst for Medtronic is the aging population. There are roughly 75 million Baby Boomers in the U.S., those aged 51-69 years. There are thousands of people entering retirement every day. Combined with longer life expectancy and rising healthcare spending, Medtronic has a long runway of growth up ahead.
Next, Medtronic has a major growth opportunity in new geographic markets. Specifically, Medtronic has a presence in several emerging markets, such as China, India, Africa, and more. These countries have large populations and high economic growth rates.
Source: August 2017 CFA Society Conference, page 8
Medtronic’s emerging-market revenue has consistently grown at a double-digit rate over the past seven years.
Another growth catalyst for Medtronic is acquisitions.
The largest single acquisition for Medtronic was its $50 billion acquisition of Covidien in 2015. The acquisition presents significant growth potential for Medtronic.
Covidien is also a medical device maker, with a focus on hospital supplies. The deal lets Medtronic broaden and diversify its product portfolio.
And, since the two companies have similar business models, there are major cost synergies as well. Medtronic expects to realize at least $850 million in cost cuts by fiscal year 2018.
Medtronic has a long history of successful acquisitions.
Source: August 2017 CFA Society Conference, page 17
In fiscal 2017, Medtronic completed 5 bolt-on acquisitions, for a total of $1.5 billion. Acquisitions are an important part of Medtronic’s growth strategy.
For the upcoming fiscal year, Medtronic expects organic revenue growth of 4%-5%, along with 9%-11% earnings growth for the year.
Revenue growth will be fueled by the core cardiac and vascular segment. Earnings growth will be driven by revenue growth, as well as margin expansion, and share repurchases.
Competitive Advantages & Recession Performance
The main competitive advantage for Medtronic is its research and development capabilities. The company spends heavily on R&D each year, which provides it with product innovation.
Medtronic’s R&D investments over the past few years are as follows:
- FY 2015 R&D expense of $1.6 billion
- FY 2016 R&D expense of $2.2 billion
- FY 2017 R&D expense of $2.2 billion
The result of all this spending, is that the company has a huge intellectual property portfolio, with over 4,600 awarded patents.
This has allowed Medtronic to build a strong product pipeline, across each of its business segments.
Source: August 2017 CFA Society Conference, page 6
Another competitive advantage for Medtronic is that it operates in a defensive industry. Consumers often cannot choose to forego medical treatments, even when the economy goes into recession.
Medtronic’s earnings-per-share during the Great Recession are as follows:
- 2007 earnings-per-share of $2.61
- 2008 earnings-per-share of $2.92 (12% increase)
- 2009 earnings-per-share of $3.22 (10% increase)
- 2010 earnings-per-share of $3.37 (5% increase)
Medtronic had the rare achievement of earnings growth each year during the recession.
This demonstrates its recession-resistant business model. Medtronic should be able to continue growing its dividend each year, in both economic recessions and expansions.
Valuation & Expected Returns
In fiscal 2017, Medtronic had adjusted earnings-per-share of $4.60. As a result, the stock has a price-to-earnings ratio of 17.2.
According to ValueLine analysts, over the past 10 years, Medtronic held an average price-to-earnings ratio of approximately 14.
While Medtronic currently trades slightly above its 10-year average, it is well below the broader market. The S&P 500 Index has an average price-to-earnings ratio of 25.5.
Medtronic still appears to be undervalued, given its high earnings growth potential.
From 2007-2016, Medtronic grew earnings-per-share by approximately 7% per year, compounded annually. This looks like a reasonable baseline of future earnings growth expectations.
Medtronic’s cash returns will also contribute to future returns. Medtronic routinely buys back its own stock, and it has increased its dividend for 40 years.
Source: August 2017 CFA Society Conference, page 15
Putting it all together, a breakdown of possible future returns is below:
- 3%-5% organic revenue growth
- 1% margin expansion
- 2% share repurchases
- 2% dividend yield
From this forecast, total returns would reach 8%-10% per year. Plus, returns would be accelerated if Medtronic’s price-to-earnings ratio expands beyond the current level of 17.2.
Final Thoughts
Medtronic has virtually all of the qualities dividend growth investors should look for. It possesses a highly profitable business, with a leadership position in its core markets. It also has multiple catalysts for future growth, and the ability to keep growing its dividend during recessions.
Medtronic is an undervalued stock, with a 2% dividend yield, and the potential for dividend increases in the high-single digits each year.
