Medical Devices

The global medical devices industry is fairly large and is valued at roughly $223 billion, with the U.S. accounting for approximately 41%. The industry is divided into different categories such as Cardiology, Oncology, Neuro, Orthopedic, Aesthetic Devices and Healthcare IT.

In the medical devices space, we recommend that investors focus on companies providing life-sustaining products. These companies provide a strong recurring stream of revenues as patients are unable to forego these products. Furthermore, investors should allocate funds to companies with high-earnings-quality profiles.

Large companies with a wide portfolio of products are also better poised for good returns. These companies are capable of withstanding the current economic recession.

Another area which is interestingly poised for growth these days is Healthcare IT. The landscape has changed since the Obama Administration passed a health care stimulus package to encourage hospitals and physicians practices to modernize their health record keeping. Names in this area include Allscripts-Misys Healthcare Solutions, Inc. (MDRX - Analyst Report), Omnicell Inc. (OMCL - Analyst Report) and Merge Healthcare Incorporated (MRGE - Analyst Report). However, none of these companies have the above-mentioned attributes that differentiate them from the others. As such, we have a Neutral rating on these stocks.

We advise investors to avoid companies that have grown historically through acquisitions. These companies may find it difficult to fund acquisitions in future. Also, they face increasing challenges in delivering operational synergies from these acquisitions, which are considered to be the prime reason for failures of Mergers & Acquisitions. Additionally, the financial statements of these companies have a large number of one-time items that affect the quality of earnings.

OPPORTUNITIES

In our portfolio, we see growth potential in companies dealing with cardiovascular devices and surgical equipment, blood related products, and associated consumables. Names currently on our Outperform list include Medtronic, Inc. (MDT - Analyst Report), Baxter International Inc. (BAX - Analyst Report), Haemonetics Corporation (HAE - Analyst Report) and Intuitive Surgical, Inc. (ISRG - Analyst Report). These are all producers of life-sustaining products and are less affected by the current economic turbulence. Among these names, Medtronic has a diversified presence in Cardiovascular, Neuro, Spinal, Diabetes, ENT, etc.

Our industry outlook would be incomplete if we did not discuss names like Boston Scientific Corporation (BSX - Analyst Report), St. Jude Medical Inc. (STJ - Analyst Report) and Becton, Dickinson and Company (BDX - Analyst Report). These are all leaders in their respective fields of Cardiology, Neuro and disposable products. These names are potential winners in the long run. However, we downgraded these stocks to Neutral based on their prior quarter results. We will closely monitor them in the next quarter results. They are strong candidates for upgrades.

WEAKNESSES

We notice weaknesses in the orthopedic market due to the current economic turbulence that has resulted in patients deferring their elective procedures. Names on this list include Conmed Corporation (CNMD - Analyst Report). However, with the economic recovery underway, a few names in this market have already been upgraded to Neutral. These include Symmetry Medical, Inc. (SMA - Analyst Report), Wright Medical Group, Inc. (WMGI - Analyst Report) and Hanger Orthopedic Group Inc. (HGR - Analyst Report).

[Industry Outlook as of October 14, 2009]