Medical Device Industry Outlook - February 2018

The Q4 earnings season is approaching its end with more than 80% of the S&P 500 companies having released their quarterly earnings. Most of the companies have incurred big one-time charges related to the change in tax law this time around. The gap between adjusted operating earnings and reported earnings is in fact the widest in recent years. The MedTech space is also not immune to the trend.

Last year, the MedTech space witnessed a good deal of uncertainty on account of a series of political events. While the Affordable Care Act (ACA) or Obamacare was not rolled back as was originally expected, the year ended with the tax overhaul. As part of the latest tax reform, corporate tax rates have been slashed to 21% from 35% earlier.

Industry Appears Vulnerable to Change

Many of the economists expect the new tax law to have a negative impact on the industry due to a possible cut in overall Medicare spending if certain criteria are not met by a specific date.

The Congressional Budget Office (CBO) apprehends that if it doesn’t find any alternative to meet the fiscal deficit from the huge tax cut, automatic cuts worth $136 billion, including $25 billion in Medicare cuts, from mandatory spending in 2018 could be triggered.

Delayed Medical Device Tax: Boon to the Industry

Amid the concerns related to the tax reform, Congress’ postponement of the medical device tax for another two years came as a huge relief to industry participants and investors. The original 2018 tax reform bill did not include any mention of this temporary repeal and investors were apprehensive that medical device tax will be reinforced in 2018.

This 2.3% tax took a toll on the entire medical device industry since its enactment in 2013. Per the Advanced Medical Technology Association lobbying group, this tax had a significant negative impact on medical innovation resulting in loss or deferred creation of jobs.

Johnson & Johnson (NYSE:JNJ) (JNJ) made a payment of $180 million as medical device sales tax in 2014. Medtronic (NYSE:MDT) (MDT), the legacy Covidien and Smith & Nephew (LON:SN) (SNN) paid $112 million, $60 million and $25 million, respectively in 2014.

Medical device giant Stryker Corporation (NYSE:SYK) reported net earnings of $1.14 billion and paid approximately $229 million as medical device excise tax in 2015 -- nearly 16% of Stryker’s bottom line income (data from a Med Device Online report). No wonder, this dreadful tax drew severe criticism from both Democrats and Republicans and was delayed by Congress in 2015 for two years.

Regarding the latest two-year suspension of the tax, Mark Leahey, President and CEO of the Medical Device Manufacturers Association (MDMA) has stated that, “Congress must permanently repeal this disastrous policy in order to fully realize the long-term investments in patient care and job creation that are critical to growth.” It remains to be seen whether the tax is fully eliminated or resumed after the two-year period. For now, the deferral will encourage R&D activities in this space.

Zacks Industry Rank

Within the Zacks Industry classification, Medical Device is broadly grouped into the Medical sector (one of the 16 Zacks sectors) and further sub-divided into four industries at the expanded level: Medical - Instruments, Medical - Products, Medical - Dental Supplies and Medical Info Systems.

We rank all 250-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each.

The Zacks Industry Rank is #168 (bottom 34% of the 250 plus Zacks classified industries) for Medical - Instruments, #179 (bottom 30%) for Medical - Products, #135 (bottom 47%) for Medical - Dental Supplies, #132 (bottom 48%) for Medical Info Systems. Our backtesting shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

Upon analyzing the Zacks Industry Rank for different Medical Device segments, it can be said that the near-term outlook for these aforementioned MedTech subsectors is bearish.

Price Performance

The price performance of two major Zacks categorized subindustries, Medical Product and Medical Instruments, however, indicate a bullish market sentiment.
Medical Product stocks have increased 2.1% in this period. Some players from this space are Haemonetics Corp. (HAE), Abbott Labs (ABT) and Boston Scientific (BSX).

Year to date, while the S&P 500 has gained 1.6%, the med instruments space has risen 7.5%. Some of the stocks within this space that have been trading above the S&P are Varian Medical Systems (NYSE:VAR), Inc. (VAR), Inogen, Inc. (INGN) and Edwards Lifesciences Corp. (EW).

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