Is Medtronic a contender for the U.S. stock market's club of elites?

Jonathan Boyar, director of Boyar Value Group and advisor to the MAPFRE AM US Forgotten Value Fund

While the financial media tends to fixate on a handful of companies, good investment ideas can also be found beyond well-known brands. Giants like Apple and Microsoft get plenty of exposure, but other industry leaders often receive far less attention. Take Medtronic (ticker: MDT), a powerhouse in the medical device industry for over 70 years. While it might not grab headlines like Magnificent 7 stocks, it is one of the leading players in the large and growing medical device field, with a market capitalization of almost $100 billion, making it a giant in its own right.

The company operates across four segments: Cardiovascular, Neuroscience, Medical Surgical, and Diabetes, each contributing to its sales of $32.4 billion for fiscal 2024 (concluded last April), marking a 4% increase from the previous year. As the global population ages and consumer/governmental expectations for superior medical care outcomes rise, Medtronic's diverse portfolio of products used in hospitals and by medical professionals throughout the world positions it well for sustained long-term growth.

Over the decades, Medtronic has demonstrated remarkable long-term performance, with tremendous total returns of approximately 9,000% including dividends since 1989, far outpacing the S&P 500's 2,297% gain over the same period. However, a number of challenges in recent years has sent its shares down by roughly 34% since July of 2021 while the S&P has staged a 33% rally. That said. . .

Given the growth trajectories of Medtronic and the broader medical device industry, we think this downturn has created an enticing opportunity for patient, long-term investors. Medtronic is selling at a significantly cheaper valuation than its peers, with the added benefit of a high dividend yield (3.5%) and with these considerations in mind, we have made MDT a core holding in the Mapfre U.S. Forgotten Value Fund.

Medtronic has navigated through various and significant challenges these last few years: It encountered pandemic-related supply shortages, temporarily reduced sales activity for medical device products, inflationary pressures, and market-specific issues like margin reductions from lower pricing in China, and delays in product approvals within the U.S. However, Medtronic is now clear of the steepest of these hurdles and has taken additional steps like diversifying its supply chain to bolster its resilience and improve stability of future revenues.

The Diabetes segment was negatively impacting financial results for a couple of years, as the company’s newest generation of insulin pumps and continuous glucose monitoring systems awaited FDA approval for an extended period of time. That overhang was finally removed back in April 2023, though, allowing Medtronic to resume sales of diabetes management devices in the U.S., the largest addressable market where it is estimated that 29 million individuals have diabetes (whether diagnosed or undiagnosed).

Despite the time it takes for sales to ramp up (as devices require prescriptions from healthcare providers), this has already resulted in a 10% increase in overall Diabetes segment sales last fiscal year. Growth is expected to accelerate this year due to increased sales of insulin pumps and recurring revenues from insulin and sensors within the expanding installed base.

Being a large business with a diverse product portfolio, it can take time to course correct, but it seems that Medtronic is back on track. It has now posted mid-single-digit top-line growth for 5 consecutive quarters, and there are fewer impediments to its growth today than at any point over the past 4 years.

Medtronic’s CFO recently departed for another opportunity, and while it is always worth monitoring any related changes to guidance or capital allocation priorities in such an event, we are cautiously optimistic that the ship will remain on a steady course. In the wake of the CFO announcement, management made it a point to reiterate its prior outlook, and we expect generous shareholder returns to remain a priority into the future, as they have for nearly half a century.

Medtronic aims to return the majority of its annual free cash flow to shareholders through dividends and buybacks. It maintains an impeccable dividend track record, with 47 consecutive years of annual increases and offers an attractive current yield of 3.5%. It also buys back its shares opportunistically, including buying back stock at a faster pace recently ($2.1 billion last year), owing to the company’s inexpensive share price and management’s confidence in its ability to deliver strong results going forward.

Looking ahead, Medtronic's strategic initiatives to enhance investments in higher growth, higher-margin business lines—such as a new robotic-assisted surgery platform—position the company well for sustained profitability and shareholder value creation. Medtronic is in the early stages of rolling out its Hugo RAS (robotic assisted surgery) platform used in operating rooms for soft-tissue surgery procedures. To date, it is only available for sale in a handful of countries and is in clinical trials in the U.S. The platform holds the possibility of billions of dollars in annual revenue down the road through equipment sales ($1 million+ for each system) and recurring revenues derived parts, consumables, and service fees to installed units.

We believe that long-term growth, value, and income investors alike may find something to like here. It is trading at less than 15x P/E, which looks like a bargain compared to an average valuation of about 30x earnings for a handful of its closest medical device manufacturer peers. MDT seems poised to generate strong total returns (dividends plus capital appreciation), via anticipated mid- to high-single-digit earnings growth, large (and modestly growing) dividend payments, and the possibility of a P/E multiple expansion.