Combine a bull market with increasing optimism that major med-tech markets are stabilizing, and it’s not so hard to see why stocks like St. Jude Medical (NYSE:STJ) have seen solid runs and enjoy pretty favorable valuations today. In the case of St. Jude, while I have generally been on the side arguing that the Street was not giving the company enough credit for its long-term prospects, the move into the mid-$40s for the stock argues that the Street has in fact come up to speed.
With that in mind, St. Jude is going to need to start outperforming to drive a significantly higher multiple and share price.
A CRM Recovery? Not So Fast…
With all of the major cardiac rhythm management companies having reported, the long hoped-for market recovery is still on the horizon. While Medtronic (NYSE:MDT) did report a good quarter for its CRM business, with revenue up 4%, management’s comments suggest that the bulk of that growth came from still more share gains from St. Jude and Boston Scientific. While the market may not be getting any worse, it certainly isn’t getting better with any particular haste.
Against that mediocre backdrop, St. Jude looks somewhat lacking in catalysts and drivers. For starters, there is still the much-publicized issue over the safety of the company’s leads (Durata and Riata) and whether that will lead to significant share shifts. Bearish Wall Street analysts still maintain that a sizable percentage of St. Jude’s market share could be vulnerable (with devastating consequences to profitability and cash flow), though recent trends and surveys suggest physicians aren’t all that troubled by the issue.
St. Jude is pursuing an MRI-safe pacemaker, and the enrollment of the U.S. study should complete later this year. Even so, it will be quite some time before St. Jude has an approved product in the U.S. and can start closing the gap on Medtronic. Likewise for the Nanostim leadless pacemaker. While this product is extremely intriguing – it’s only 1 cc in volume and is delivered through a pacemaker – it is still a ways away from primetime. Even so, recently data presentations have been compelling and the acquisition of the remainder of Nanostim (St. Jude is an investor with an option to buy) could bring more attention to this opportunity.
Along similar lines, investors may get some good news related to CardioMEMS. This company has developed tiny permanent implants that can monitor cardiac function (heart rate, flow, etc.) and transmit that data wirelessly. CardioMEMS still has a warning letter to resolve and it’s uncertain if it can gain approval without another trial, but here too St. Jude has the option to buy the company and wireless monitoring could be an intriguing opportunity.
How Much Will A Failure To Lead Cost St. Jude?
One of the frequent, and frankly valid, complaints about St. Jude is that they’re seldom first to the table with new technologies. Medtronic will have been on the market with an MRI-safe pacemaker for years before St. Jude gets to market, and Boston Scientific (through Cameron) has beaten them with the S-ICD product. While Nanostim and CardioMEMS could be first-to-market products, that’s more of the exception than the rule.
St. Jude’s Portico transcatheter valves do seem to offer some advantages over the Edwards Lifesciences (NYSE:EW) Sapien and Medtronic CoreValve valves (including the ability to resheath and reposition, as well as cuff design that reduces leakage). Still, I have to wonder whether Edwards and Medtronic will already have follow-up products with improved features in trials before Portico launches in the U.S., to say nothing of established market share and a large base of physicians already experienced with their products.
So too in renal denervation. I do believe that renal denervation (to treat drug-resistant hypertension) will be a multi-billion dollar market assuming that the efficacy and safety data hold up over the long term, but Medtronic will almost certainly get to market before St. Jude, and St. Jude could end up slipping behind Covidien (NYSE:COV) or Boston Scientific along the way. On a more positive note, I do believe St. Jude has an edge with its multi-electrode catheter design, and being second to market doesn’t hurt much if/when the product is better.
Investors should also note that the company will be launching an outcomes study for the EnligHTN product, and while there’s a risk that all renal denervation products will benefit from a positive study, showing positive real outcomes (lower rates of stroke, heart attack, death, and so on) could be powerful given the recent debate over the validity of niaspan and fish oil in controlling cholesterol and improving long-term outcomes.
Can New Products/Indications Carry The Load In The Meantime?
Even if products like CardioMEMS, Nanostim, EnligHTN, and Portico do better than analysts expect, they won’t help for a few years. In the meantime, St. Jude will need to hope that new opportunities in atrial fibrillation and neuromodulation live up to their promise.
St. Jude has a big market share in atrial fibrillation (roughly one-third share, against Johnson & Johnson (NYSE:JNJ) nearly 50% share), and new catheter launches in the second half of this year could help maintain one of the strongest growth markets in med-tech right now. More significant could be the MediGuide platform – a diagnostic tool that promises to lower the fluoroscopy load and procedure times for ablation procedures.
Neuromodulation is less certain. St. Jude has established itself as the leader in FFR over Volcano (NSDQ:VOLC) and has the edge in OCT as well for now. There is still the risk, though, that Volcano will prevail in its patent litigation against St. Jude, that a major rival (like Medtronic or Boston Scientific) will buy Volcano, and/or that procedure follows trail off in the more adverse reimbursement environment. At the same time, while there’s still potential in St. Jude’s more traditional neurostim business (the Advanced Neuromodulation business), that business has been weaker of late.
The Bottom Line
While products like the Nanostim leadless pacemaker, the Portico heart valve, and the EnligHTN renal denervation catheter are all promising, their potential is tempered by some less favorable realities. St. Jude faces fierce competition in most of its markets and it takes significant product launches and incremental innovation just to keep pace. What’s more, St. Jude has not established itself as a top-notch operator in recent years, and that makes it harder to argue that the company’s second/third-to-market products will significantly disrupt the incumbents.
To that end, I’m looking for long-term free cash flow growth of about 4% from St. Jude (about one point higher than Medtronic, and about half that of Boston Scientific, though BSX has a much lower starting point). That works out to a fair value of about $43 today, with every half-point of long-term free cash flow growth changing the fair value by about $2/share.
While I do believe that the Street has been too hasty in rewarding St. Jude with a better multiple, I still do like this company on balance. Were the stock to pull back below $40 I’d be interested again, but I’m more interested in stocks like Medtronic and Stryker (NYSE:SYK) at current prices.