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Covidien's Q3 Earnings Beat; Sales Lag

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Covidien plc. posted adjusted earnings per share from continuing operations of 91 cents for the third quarter of fiscal 2013, flat year over year. However, earnings beat the Zacks Consensus Estimate by a penny. Adjusted earnings exclude one-time items such as tax-related expenses, restructuring and acquisition related charges.

For the quarter under review, net income from continuing operations (as reported) inched up 1.3% to $400 million (or 85 cents a share) from $395 million (or 81 cents) in the prior-year quarter.

Covidien successfully completed the divestment of its Pharmaceutical unit in the third quarter, which has been accounted in the discontinued part of the company’s results.


Revenues in the third quarter increased 3% (up 5% in constant currency) to $2,578 million, driven by higher sales in the Medical Devices segment. Sales were slightly below the Zacks Consensus Estimate of $2,587 million.

On a geographic basis, revenues in the U.S. market decreased 3% to $1,299 million. International sales climbed 10% (up 14% in constant currency) to $1,279 million, driven by emerging market growth.

Segment Analysis

Revenues from the larger Medical Devices segment grew 4% (up 6% in constant currency) to $2,139 million. The division is benefiting from new product offerings and higher volumes.

Within Medical Devices, revenues from Endomechanical Instruments increased 5% to $632 million, led by solid gains from Tri-Staple reloads. Sales of Soft Tissue Repair products inched down 1% to $224 million, as soft sales of biologic mesh mitigated double-digit growth of synthetic mesh. Further, Airway & Ventilation sub-segment sales rose 4% to $192 million.

Revenues from Energy Devices climbed 8% to $355 million, again reflecting strong double-digit vessel sealing sales. Revenues from Oximetry and Monitoring sub-segment rose 13% to $237 million, owing to higher sales of sensors acquired from Oridion. However, Vascular product sales inched down 1% to $415 million, as solid growth of chronic venous insufficiency offerings was dampened by depressed compression and dialysis products sales.

Sales from Medical Supplies segment inched down 1% to $439 million in the quarter as increased sales of Nursing Care offerings was offset by soft SharpSafety, Medical Surgical and OEM product sales.

On an adjusted basis, gross margin dropped 100 bps to 59.5% in the quarter due to unfavorable foreign exchange rates. Selling, general and administrative expenses increased 3.1% to $853 million in the reported quarter due to foreign exchange fluctuations, the medical device excise tax as well as sales and marketing initiatives in emerging markets, partially offset by improved productivity. R&D expenses grew 3.2% to $129 million. Adjusted operating margin dipped 160 bps to 21.5% in the quarter.

Share Repurchase

Covidien repurchased roughly 9.4 million ordinary shares under its share buyback program in the third quarter. Shares outstanding at the end of quarter were $469 million.

Our Take

Covidien’s mixed third-quarter results keep us on the sideline. Although the company is gaining significant grounds in emerging markets, tepid growth in the U.S. is a matter of concern. Further, the lack of a guidance (which the company suspended due to the divestment of the Pharmaceutical segment) lowers visibility on the stock.

The company is adequately placed to achieve its long-term revenues and earnings growth targets based on its attractive fundamentals, strategic R&D investment, effective execution, new product cycle and expansion into the emerging markets. It is also enhancing shareholder value through dividends and share repurchases, leveraging healthy free cash flow and strong earnings power.

However, Covidien faces stiff competition and remains exposed to pricing and utilization headwinds, along with acquisition risks. In addition, foreign exchange translation is expected to dampen growth.

Covidien currently carries a Zacks Rank #3 (Hold). Other companies like Hospira , Alere and Boston Scientific (BSX - Free Report) , are expected to do well in the medical industry. Hospira carries a Zacks Rank #1 (Strong Buy), while the other two stocks carry a Zacks Rank #2 (Buy).

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