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ETF News And Commentary

Medtronic Inc. (MDT - Analyst Report), the world's largest standalone medical device maker, has reported soft results for its fiscal fourth-quarter 2014. Though the company reported earnings at par with our expectations, it missed out on revenues.

The silver lining to Medtronic’s weak results was its announcement that it will settle its long standing bitter litigation with rival Edwards Lifesciences Corporation (EW - Analyst Report) over patent disputes.

Medtronic has agreed to pay Edwards a one-time payment of $750 million, and ongoing royalty payments through April 2022 based on a share of CoreValve (artificial heart valve) sales, in payments not less than $40 million annually.

MDT Earnings in Focus

One-time charges to Edwards as well as some other litigation related charges have taken a toll on Medtronic’s fiscal fourth quarter profits. The company reported net income of $448 million or 44 cents a share, both down 54% on a year-over-year basis (read: Merck (MRK) Earnings Beat Puts Healthcare ETFs in Focus).

However, excluding the one-time items, the company’s adjusted earnings per share (EPS) increased 2% year over year to $1.12, in line with Zacks Consensus Estimate.

Revenues came in at $4.566 billion, up 2% year over year led by stronger sales of diabetes products. However, revenues were marginally below the Zacks Consensus Estimate of $4.575 billion.

Revenue weakness came in largely from Implantable Cardioverter Defibrillators (ICD). Moreover, sluggish revenues from the Cardiac Rhythm Disease Management (CRDM) were also a matter of concern.

Guidance

Medtronic expects fiscal 2015 EPS in the range of $4.00 to $4.10, in line with the Zacks Consensus Estimate of $4.09. Moreover, the company expects revenues to grow in the range of 3% to 5% at constant exchange rates, in line with our estimate of a 3.6% annual growth (read: Medical Device ETF Investing 101).

ETF Impact

Though the company’s guidance came in line with the consensus, soft results and huge one-time charges dragged Medtronic’s shares into the red during Tuesday’s trading session. Its share prices slipped 1.54% to close at $59.41 for the day.

iShares U.S. Medical Devices ETF (IHI - ETF report) having a sizeable exposure to Medtronic wasn’t spared either. The ETF fell close to 1.2% on the day, with heavy volume of 301,000 shares. This was almost three times the fund’s daily average level.
 
Medtronic, which is considered as a bellwether in the medical device industry, occupies the second spot in the product having 10.92% allocation, close to the ETF’s top holding Abbott Laboratories (see all Healthcare ETFs here).

Moreover, considering the fact that the fund holds just a small basket of 50 stocks, any further downward movement in Medtronic’s share prices is expected to hit IHI. Hence, investors should keep a close watch on this medical device ETF.

Though the fund has outperformed the broader market ETF SPDR S&P 500 (SPY) in the year–to-date frame, it has marginally underperformed the broad-based Healthcare fund SPDR Select Sector Health Care ETF (XLV - ETF report) (read: Pharma ETFs: A Safe Haven from the Biotech Stock Slump?), signaling some pressure ahead.

Thus with one of the kings in the medical device industry disappointing investors, IHI could see volatile trading days ahead. Having said that, the long-term story doesn’t look so bad. Medtronic is trying every means to boost its growth. The company is expanding its product portfolio and also penetrating into key international markets.

This should bode well for Medtronic and consequently for IHI too. We currently have a Zacks ETF Rank #3 or Hold rating for IHI, indicating that it still has some more room for upside.

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