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Medical - Products Stock Outlook: Short-Term Pain Inevitable

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The medical products sector has been gaining prominence on the back of encouraging demographics, changing market dynamics toward Artificial Intelligence (AI), big-data applications and increased business investments.

However, the space witnesses hindrance from short-term hurdles associated with the U.S.-China trade war.

Yesterday, the Trump administration announced a new round of tariffs (almost 10%) on about $200 billion on Chinese imports, effective from Sep 24. By Jan 1, 2019, the tariffs are likely to rise to 25%. Not to forget, a significant amount of these imports are medical products, devices and medical imaging components.

According to a recent survey conducted by the Medical Imaging & Technology Alliance (MITA), the tariffs will cost the medical products companies nearly $140 million per year. Thus, the companies will be compelled to reduce U.S. workforces and their investments in R&D to fund this ‘new and unnecessary expense’. Peter Roff, Fox News, criticized the latest decision and stated, “The American people, some businesses and the nation’s health care will all be harmed to a considerable degree by the imposition of tariffs President Trump announced Monday”.

Despite these short-term geo-political uncertainties, the long-term prospects of the Medical - Products industry are bright at the moment.

In the past decade, the industry has witnessed major improvements in precision surgeries, gene therapies, hybrid closed-loop insulin delivery systems, continuous glucose-monitoring platforms, centralized monitoring of hospital patients and electronic health records (EHR). Additionally, a bipartisan two-year suspension of a 2.3% excise tax on Medical Product and Medical Device manufacturers at the beginning of 2018 has encouraged massive investments in the sector.

Industry Performance vs. S&P 500

The Zacks Medical – Products Industry, within the broader Zacks Medical Sector, has outperformed the Zacks S&P 500 Composite and its own sector in the past year. While stocks in the industry have collectively gained 21.2%, the Zacks S&P 500 Composite improved 16.5% and the Zacks Medical Sector rose 9.8%.

One-Year Price Performance

Looking at shareholders’ returns over the past year, it is quite apparent that investors are quite optimistic about the industry’s prospects.

The industry is catching up with the digital-data age. The latest trend of adopting EHR, Electronic Medical Records and Predictive Analytical services has been gaining popularity in the U.S. MedTech space.

However, headwinds such as increased operating expenses on account of higher R&D investments cannot be ignored. This may strain margins in the short run.

Zacks Medical – Products Stocks Trading Cheap

In spite of outperforming the broader market in the past year, the Medical - Products industry has been trading quite cheap right now.

Valuation is a tricky business for the medical product companies. Not to forget, these companies invest significantly on unplanned R&D and hence it is difficult to account for such high expenses. However, one might gain a fair idea of the industry’s relative valuation from its Price/Book ratio.

The industry currently has a Price/Book TTM ratio of 3.35, which is significantly above the median level of 2.84.

The space also looks inexpensive compared with the Medical market at large, as the current Price/Book TTM ratio for the Medical sector is 4.50 and the median Price/Book TTM ratio is 3.17.

Price-to-Book Trailing Twelve Months (TTM)

The space looks inexpensive compared with the Zacks S&P 500 composite. The current ratio for the S&P 500 is 4.08 and the median level is 3.84. So, the figures are above the medical products industry’s respective ratios.

Price-to-Book Trailing Twelve Months (TTM)

Dim Earnings Outlook Keeps Us Cautious

Despite the strong price movements and inexpensive nature of the medical products stocks, there are a few factors that have been denting the industry’s growth in the short term. Of the major issues, trade-war definitely tops the list.

Further, there has been regulatory hurdles in the space. For instance, the Unique Device Identification (UDI) system by the FDA has been quite costly and difficult to implement for the medical product manufacturers.

Adding to the woes, the medical-device tax repeal amendment is a temporary relief for manufacturers. It will be back again in 2020.

One reliable metric that can give investors an idea of the industry’s future price performance is its earnings outlook. Empirical research shows that earnings outlook for the industry, projecting the earnings revision trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry indicates the market's evolving bottom-up earnings expectations for and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line shows the same for 2018.

Price and Consensus: Medical – Products industry

Please note that the $2.52 EPS estimate for the industry for 2018 is not the actual bottom-up EPS estimate for every company in the Zacks Medical – Products industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the EPS of the industry for 2018 but how this estimate has been moving recently.

This becomes clear by focusing on the aggregate EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Current Fiscal Year EPS Estimate Revisions

As you can see, the $2.52 EPS estimate for the Zacks Medical - Products industry implies a deterioration of 7.7% on a year-over-year basis.

Looking at the earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings potential. This could possibly be due to the challenges associated with the continuous technological advancements within the Medical – Products industry and trade-war fears.

Zacks Industry Rank Indicates Bleak Near-Term Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates underperformance in the near term.

The Zacks categorized Medical - Products industry currently carries a Zacks Industry Rank #180, which places it in the bottom 30% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry’s rank was in the bottom 40% for the past three weeks.

Medical – Products Industry Promises Long-Term Growth

Interistingly, the long-term prospects for the industry indicate steady growth. When compared with the broader Zacks S&P 500 composite, the long-term (3-5 years) EPS growth estimate for the Zacks Medical – Products industry of 10.4% appears promising. The corresponding figure for the Zacks S&P 500 composite is 9.8%.

The group’s mean estimate of long-term EPS growth rate has been declining from the high of 10.7% achieved in December 2017, and the current estimates are near the median level in a year’s time.

Mean Estimate of Long-Term EPS Growth Rate

In fact, the basis of this long-term EPS growth could be a steady increase in the top line that the Medical - Products industry has seen since the end of 2014.

Bottom Line

The U.S.-China trade war is gradually becoming more intense with no signs of relaxation anytime soon.

If China takes further retaliatory action on yesterday’s decision, Trump has promised to impose higher tariffs (phase three) that will be on $267 billion of additional Chinese imports. Needless to say, this has triggered a short-term decline in the sector. Thus, the Medical - Products industry might not be able to tide over the broader challenges in the near term.

However, keeping the long-term expectations in mind, investors can take advantage of the cheap valuation and bet on a few medical product stocks that have a strong earnings outlook.

Here we pick stocks from the Medical - Products industry with a Zacks Rank #1 (Strong Buy) or 2 (Buy), which have seen positive earnings estimate revision. You can see the complete list of today’s Zacks #1 Rank stocks here.

Surmodics, Inc. (SRDX - Free Report) : Headquartered in Eden Prairie, MN, Surmodics is a leading provider of medical devices and In Vitro Diagnostics (IVD) technologies to the healthcare industry. The stock flaunts a Zacks Rank #1.

The Zacks Consensus Estimate for current-year earnings is pegged at 43 cents, up from a loss of 2 cents estimated 60 days ago. Surmodics’ shares have returned 156% in a year’s time.

Price and Consensus: SRDX

Quidel Corporation (QDEL - Free Report) : Headquartered in San Diego, California, Quidel manufactures and markets point-of-care, rapid diagnostic tests for detection of medical conditions as well as illnesses. The stock sports a Zacks Rank #1.

The Zacks Consensus Estimate for current-year earnings increased 7.7% in the past 60 days. The stock has returned 64.3% in a year’s time.

Price and Consensus: QDEL

ICU Medical, Inc. (ICUI - Free Report) : Headquartered in San Clemente, California, ICU Medical develops, manufactures and sells medical devices used in vascular therapy, critical care as well as oncology applications worldwide. The stock sports a Zacks Rank #1.

The Zacks Consensus Estimate for current-year earnings increased 13.7% in the past 60 days. The stock has returned 49.7% in a year’s time.

Price and Consensus: ICUI

Abbott Laboratories (ABT - Free Report) : Abbott Park, IL-based Abbott discovers, develops, manufactures and sells a diversified line of health care products. The stock has a Zacks Rank #2.

The Zacks Consensus Estimate for current-year earnings increased 15.2% on a year-over-year basis. Abbott’s shares have returned 29.9% in a year’s time.

Price and Consensus: ABT

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