St. Jude Can Keep Your Portfolio Pumping -- But Wait For Price Drop

If your heart is not pumping with a regular rhythm, then you've got yourself a serious problem. But if so -- and you're still reading this -- it may be because you are a customer of the  cardiovascular rhythm management (CRM) industry.

CRM makes devices that doctors implant in your chest -- they give you a nice electric shock to get your heart pumping if it gets off track. And the industry is big -- although shrinking. Should you invest in it? If so, what are the prospects for profit in the stocks of Medtronic (NYSE: MDT) and St Jude Medical (NYSE: STJ).

The CRM market is big but shrinking. According to Medtech Insight, the global CRM market is likely to total $11.4 billion in revenue, down 2% from 2010. The reason for the decline is research that argued CRM products are mis-used and a Department of Justice investigation into the industry.

A January 2011 study in the Journal of the American Medical Association argued that "a substantial percentage of US physicians may not be following evidence-based guidelines" for CRM devices. Though its findings are controversial, the study suggests that some patients may be getting the devices even though that might not be the best treatment for what ails them.

And it that was not bad enough, there is an ongoing DOJ investigation into whether health care providers are improperly billing Medicare for CRM devices.  Specifically, the DOJ is trying to gather evidence of whether providers are improperly billing Medicare for "nonqualified [implantable cardioverter defibrillators] ICD implants." reports Medtech Insight.

Medtronic and St. Jude are big players in this industry. MEdtronic has 45% of the U.S. ICD market and St. Jude has 27%. But a JPMorgan analyst, Michael Weinstein, sees a rapidly contracting market -- he expects the US ICD market to get smaller at a 5.2% annual rate from $4.18 billion in 2010 to $3.38 billion in 2014.

Medtronic has been affected by this contraction. And that contributed to low expectations for its fiscal second quarter 2012 results. FactSet-polled analysts were expecting earnings of 82 cents on revenue of $4.07 billion. The EPS expectations for Tuesday's report was the same as the same period in 2010 while the revenue forecast was up 4.4% from the year before.

Medtronic's actual result was good and the stock is rising in pre-market as a result. Revenue was $4.13 billion -- $40 million higher than forecast and EPS of 84 cents were two cents more than forecast.



St. Jude has been performing more impressively. When it reported results in October, its adjusted EPS of 78 cents for the third quarter beat expectations by six cents a share. And its revenues increased 11.5% to $1.38 billion -- beating the Zacks Consensus Estimate by around $10 million. Although St. Jude had problems in its CRM product line, other products offset the bad news.

So here's what the investment choice between Medtronic and St. Jude boils down to:

• Medtronic: barely growing, wide margins; expensive stock. Medtronic sales have risen 0.7% in the past 12 months to $16.2 billion, while net income has slipped 0.1% to $3.1 billion – yielding an impressive 19.1% net profit margin. Its PEG of 1.37 (where a PEG of 1.0 is considered fairly priced) is expensive on a P/E of 11.6 and expected earnings growth of 8.5% to $3.73 in fiscal 2013.
• St. Jude: growing, wide margins; expensive stock. St. Jude sales have sales have risen 10.3% in the past 12 months to $5.56 billion, while net income has increased 16.8% to $907 million -- yielding a solid net margin of 16.3%. Its PEG of 1.34 is expensive on a P/E of 12.9 and expected earnings growth of 9.6% to $3.58 in 2012.

Medtronic and St. Jude are over-valued given their slow expected earnings growth. If forced to choose, I would pick St. Jude because it's growing faster. In light of the never ending drip of nasty global debt rumors, keep an eye on St. Jude for an opportunity to buy its shares at a lower price.