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On May 27, we downgraded medical device company, Covidien plc. (COV - Analyst Report) to Underperform based on the company’s disappointing outlook for 2013.

Why the Downgrade?

Estimates for Covidien have been declining ever since it reported its guidance for fiscal 2013. For fiscal 2013, Covidien expects net revenue to grow by 4% to 5% (earlier 5% to 8%) year over year. The company’s core Medical Devices segment is expected to be up 4%–6% (earlier 5%–8%) and the Medical Supplies business is expected to grow 1%–2% (earlier 1%–3%) year over year.

Management has lowered its guidance due to the unfavorable foreign currency fluctuations. Operating margin is also expected to remain under pressure. Additional future investment-related expenses might further drag down the company’s margins.

Moreover, the company reported soft second-quarter fiscal 2013 results on Apr 26. Net income from continuing operations (as reported) dropped 10.2% on account of higher expenses.

Following the release of the second-quarter results and the guidance for fiscal 2013, the Zacks Consensus Estimate for 2013 has significantly gone down 17.8% to $3.70 per share. The Zacks Consensus Estimate for 2014 has also declined 17.1% to $4.06 per share. With the Zacks Consensus Estimate for both 2013 and 2014 going down, the company now has a Zacks Rank #5 (Strong Sell).

Cause for Concern

We remain on the sidelines regarding risks associated with the divestment of the Pharmaceutical unit (Mallinckrodt) by the end of third quarter of fiscal 2013. The Pharma business is performing well and contributing significantly to the top line. Following its divestment, Covidien will be left with only the Medical Devices and Supplies businesses. Given the current difficult healthcare environment, uncertainty looms over the growth prospects of these two businesses.

Moreover, bad news like the termination of a contract, reactor shutdown along with pricing pressure, raw material cost inflation and higher debts add to our concern. Given the challenging outlook, we fail to see any significant catalyst that could drive the shares in the near term. As a result, the Zacks Consensus Estimate for the third quarter has gone down 21.1% to 90 cents.

Med-Tech Stocks That Warrant a Look

While we prefer to avoid Covidien until we see signs of improvement in the company's performance, other medical device stocks worth a look are Conceptus , Neogen Corp. (NEOG - Snapshot Report) and Myriad Genetics (MYGN - Analyst Report). While Conceptus carries a Zacks Rank #1 (Strong Buy), the other two stocks carry a Zacks Rank #2 (Buy).

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