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Recently, Covidien plc (COV - Analyst Report) completed the divestment of its Pharmaceutical unit, Mallinckrodt. The company had taken this initiative to streamline its business and focus on its remaining Medical Devices and Medical Supplies businesses.

Mallinckrodt started to trade independently on the New York Stock Exchange (NYSE) from Jul 1, under the ticker symbol “MNK”. Meanwhile, Covidien will continue to trade with the same ticker symbol “COV”. Shareholders received 1 ordinary share of Malinckrodt in lieu of every 8 ordinary shares of Covidien.

Management believes that the divestment will be beneficial to Covidien’s shareholders in the long term, as it will help the company focus on its high-margin surgical product portfolio. Moreover, management reiterated the long-term goal of generating mid-single digit top-line growth and double-digit bottom-line growth. Additionally, the company retained its commitment to return up to 50% of its free cash flow to its shareholders.

Our Take

We are apprehensive regarding the risks associated with this divestment. Mallinckrodt was performing well and contributing significantly to the top line (17% of net sales in fiscal 2012). This segment generated revenues of about $2 billion in fiscal 2012. Given the current difficult healthcare environment, uncertainty looms over the growth prospects of the two remaining businesses at Covidien.

Further, 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 weigh on Covidien’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).

While we prefer to avoid Covidien until its performance improves, other medical device stocks worth a look are Wright Medical Group (WMGI - Analyst Report), Edwards Lifesciences (EW - Analyst Report) and Hanger (HGR - Analyst Report). While WMGI carries a Zacks Rank #1 (Strong Buy), the other two stocks carry a Zacks Rank #2 (Buy).

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