MedTech Tailwinds At A Glance: Which Stocks To Buy?

Over the past few years, the U.S. medical device market has undergone a substantial transformation. While there are a lot of thorny regulatory and financial issues that hardly look resolved anytime soon, the powerful long-term tailwinds, including mergers & acquisitions, emerging market expansion, positive demographic trends and new product innovation have been the vital force behind the continued uptrend of the sector’s performance.

In addition, the recent change in consumer demand and market dynamics have led to a dramatic transformation in the healthcare system. This is evident from the growing prevalence of minimally invasive surgeries, rising demand for liquid biopsy tests, use of IT for ensuring quick and improved patient care and the shift of the payment system to a value-based model, among others.

Adding to the advantage is the temporary two-year suspension of the controversial and dreadful 2.3% medical device excise tax which took a toll on the entire MedTech industry since its enactment in 2013.Data published in a report in FierceMedical Device stated that in 2014, Johnson & Johnson (NYSE:JNJ) (JNJ) made a payment of $180 million in medical device tax payments, while Medtronic (NYSE:MDT) (MDT), legacy Covidien and Smith & Nephew (LON:SN) (SNN) paid $112 million, $60 million and $25 million, respectively.

Let’s go through some of the major long-term tailwinds of the MedTech sector. These include M&A, Divestment and Emerging Market.

M&A Boom Continues

Going by the last available EvaluateGroup data, the first half of 2015 saw 86 mergers and acquisitions, totaling $83 billion, a rise of 166% from the year-ago period. Although the next report is not yet released, the unofficial talk is that the full-year target of $100 billion of M&A valuation was effortlessly reached with the legacy continuing into 2016.

Medtronic (MDT), after its path breaking $42.9 billion acquisition of Irish rival Covidien (in Jan 2015), has not taken a breather from strategic M&As. Among many others, the company recently entered into an agreement to buy Heartware International for a total value of $1.1 billion. This acquisition is expected to significantly boost Medtronic’s cardiac rhythm and heart failure business, alongside providing a strong foothold in the global niche.

Some other significant consolidation deals of recent times are discussed below:

Abbott Laboratories (NYSE:ABT) (ABT) - St. Jude Medical (STJ): In April, Abbott announced its decision to consolidate with St. Jude Medical for a deal value of $25 billion. Post completion, this will create a leader in high-growth cardiovascular markets, including atrial fibrillation, structural heart and heart failure as well as earn a leading position in the high-growth neuromodulation market.

DENTSPLY International (NASDAQ:XRAY) (XRAY) - Sirona: A $5.5 billion acquisition that closed in March, this consolidation is aimed at forming a leading global manufacturer of professional dental products and materials.

Thermo Fisher (TMO) - Affimetrix:Thermo Fisher, following the Life Technologies buyout, has undertaken several meaningful acquisitions as part of its strategy to effectively deploy capital. The latest in the league was the company’s acquisition of Affymetrix for a value of $1.3 billion. The acquisition is expected to boost Thermo Fisher’s biosciences and genetic analysis portfolio.

Thermo Fisher - FEI Company (FEIC): Thermo Fisher’s plan to buy FEI Company for $4.2 billion will enable it to access FEI’s industry leading high-performance electron microscopy platform used for protein study, which in turn facilitates life-science research.

Medtronic (MDT) – HeartWare (HTWR): This June, Medtronic entered into an agreement to buy Heartware International Inc. for a total value of $1.1 billion. This acquisition is expected to significantly boost Medtronic’s cardiac rhythm and heart failure business, alongside providing a strong foothold in the global niche.

Zimmer Biomet – LDR Holding Corp. (LDRH): Zimmer Biomet’s spine portfolio is expected to get a major boost with the impending acquisition of the French spine device maker LDR Holding Corp. (LDRH), for a total deal value of $1 billion.

Divestments

The medical device majors continue to offload their non-core business segments, specifically to focus on the main segments and also to divest assets that are similar to the ones acquired through mergers, as required by the U.S. Federal Trade Commission (FTC) and other international anti-trust regulators. This restricts the chance of monopoly practice in the market.

Let’s take a look at some of the significant divestments of recent times.

Bayer (DE:BAYGN), who had sold off its diabetes devices unit to Japan-based Panasonic Healthcare Holdings Co., for $1.13 billion in Jan 2016, is once again preparing to spin off its radiology supplies business valued at $3 billion. According to the company, while the sale of the loss-making diabetes devices unit will enable it to focus more on its profitable life-sciences operations, the radiology business divestment is a part of the company’s initiative to acquire agrochemical giant Monsanto (NYSE:MON) under a mega $62 billion deal.

In Mar 2016, Mindray Medical International Limited declared its sell-off to Solid Union Limited, a wholly owned subsidiary of Excelsior Union Limited, for $28 per American Depositary Share (ADS).

In Jan 2016, VCA Inc. (WOOF), a healthcare major, sold off a majority interest in its subsidiary Vetstreet, Inc. -- a software as a service (SaaS) provider of marketing solutions and health information analytics to veterinary practices and animal health product manufacturer – to Henry Schein (NASDAQ:HSIC), a provider of health care products and services to office-based dental, animal health and medical practitioners.

Huge Emerging Market Openings

As per recent data from Euromonitor International, the global medical device production value is likely to register strong growth of almost 6% in 2016, to reach $315 billion. While the traditional market continues to be plagued by difficulties, thanks to growing regulatory scrutiny and pricing pressure and the emerging markets of Latin America and Eastern Europe are showing no signs of turnaround (the healthcare industry’s turnover in Brazil and Russia is estimated to decline by 3% and 2%, respectively, over 2016), it’s the Asia Pacific region on which all the bets are placed this year.

The MedTech market in Asia Pacific grew the fastest at a CAGR of 10% during 2008–2014 and is expected to continue to grow rapidly over 2016 as well. According to the report, China’s and India’s healthcare service revenues are expected to grow by 12% and 9%, respectively, in 2016 alone, resulting in a large number of new hospital construction projects and soaring demand for medical and surgical equipment.

Abbott continues to lead the emerging market investment trend with about 50% of sales from this region. In the first quarter of 2016, sales in key emerging markets climbed 12% driven by growth in India and China.

At Medtronic, while growth in the rest of the world was low to declining, the emerging markets demonstrated strong growth in its fourth quarter of fiscal 2016, which contributed 185 basis points (bps) to the company’s overall revenue growth. Post Covidien integration, the combined entity is likely to generate about $27 billion in total revenue, including $3.7 billion from emerging markets.

Boston Scientific Corporation (NYSE:BSX) (BSX) achieved 21% organic growth in emerging markets in the first quarter of 2016, ahead of the company’s target of reaching 15% of sales by 2017 from 8% in 2013.

Strongest Links

Among the medical product stocks, companies like NuVasive, Inc. (NUVA) and GW Pharmaceuticals plc (GWPH) look attractive, with both sporting a Zacks Rank #1 (Strong Buy). Boston Scientific Corp. (BSX), Zimmer Biomet Holdings, Inc. and St. Jude Medical Inc. (STJ) are also well positioned with a Zacks Rank #2 (Buy).

In the medical instrument space, we are positive on ABIOMED, Inc. (ABMD), Masimo Corp. (MASI) and Mesa Laboratories Inc. (MLAB) among others, all carrying a Zacks Rank #1. Besides, Steris Plc (STE), Natus Medical Inc. (BABY) and Hologic Inc. (HOLX), all with a Zacks Rank #2, are also expected to do well.

Weaker Stocks

Coming to the weakest links in the MedTech sector, we advise investors to stay away from names that offer little growth/opportunity in the near term. These include companies for which estimate revision trends reflect a bearish sentiment.

Stocks which do not look inspiring are DexCom, Inc. (DXCM), ConforMIS, Inc. (CFMS), Intuitive Surgical (NASDAQ:ISRG), Inc. (ISRG), ResMed Inc. (RMD), Smith & Nephew plc (SNN) and Meridian Bioscience, Inc. (VIVO) all carrying a bearish Zacks Rank #4 (Sell). Phibro Animal Health Corporation (PAHC) and Community Health Systems, Inc. (CYH) bear a Zacks Rank #5 (Strong Sell).