Wednesday, November 21, 2012

Opportunities In The Medical Technology Sector

It used to be that the medical device group was the darling of growth stock investors.

Names like St. Jude Medical; Medtronics;  Stryker; and Johnson and Johnson were staples of growth stock portfolios. These companies were rapid growers - and highly profitable - as need for such products as stents and artificial hips and knees seemed insatiable.

However, the landscape has changed in the last few years.  Hospitals are under constant pressure to try to contain costs. Insurers are questioning more of the need and expense of patient procedures.  With the passage of the Afforable Care Act (a.k.a Obamacare) in March 2010, growth rates among the medical device group will probably continue to be sluggish.

I had the chance to hear Bob Hopkins of Merrill Lynch yesterday.  Bob has been following the medical technology field for almost 15 years now. In my opinion, he is one of the best analysts in the sector, so I was eager to hear his thoughts.

Surprisingly, Bob now finds more opportunities in his sector than he has for some time.

True, said Bob, most of the stocks are unlikely to see the kind of growth rates they experienced in the 1990's.  At the same time, company managements have been surprisingly nimble in turning their companies from a pure growth focus to ones that have a focus on operation efficiency.

Gone are the days of rapid employment growth - many companies are now laying off workers in order to align their cost structures with a slower growth environment.

In addition, company managements are under increasing pressure from investors to be better stewards of their capital.

As an example, Bob said that he had recently been on the road with management from Stryker Corporation for a series of meetings with investors.

In nearly every meeting, Bob reported, investors were constantly asking what management plans were for the large ($4 billion) hoard of cash that Stryker had accumulated.  By the end of the day, Bob said, company CEO Kevin Lobo said "I get it!". Bob feels that it is likely that the company is likely to return at least a portion of their cash to shareholders either through stock buybacks and/or higher dividends.

From an investors' standpoint, Bob feels his group now offers a number of attractive opportunities. 

As the chart above indicates, stocks prices of many medical technology companies have lagged the rest of the health care sector, and valuations now are now compelling on a number of stocks.

In particular, Bob felt that Stryker (SYK) and Zimmer Holding (ZMH) were attractive, but he also liked Covidien (COV) as well. 

That said, Bob is not unaware that it is unlikely that the medical technology will soon return to the explosive growth rates of earlier decades.  Investors in the group will not only need to able to see the opportunities that market sell-offs present, but also be aware that there will also be times that the stocks will get ahead of the fundamentals.