Medtronic’s Efforts To Remodel Its Portfolio Are Beginning To Bear Fruit

Senior Equity Analyst

Debbie Wang

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Cardiovascular

Medical Surgical

Neuroscience

Diabetes

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Medtronic's standing as the largest pure-play medical-device maker remains a force to be reckoned with in the med-tech landscape. Pairing Medtronic's diversified product portfolio aimed at a wide range of chronic diseases with its expansive selection of products for acute care in hospitals has bolstered Medtronic's position as a key partner for its hospital customers. 

Medtronic has historically focused on innovation, designing and manufacturing devices to address cardiac care, neurological and spinal conditions, and diabetes. All along, the firm has remained focused on its fundamental strategy of innovation. It is often first to market with new products and has invested heavily in internal research and development efforts as well as acquiring emerging technologies. However, in the postreform healthcare world where there are higher hurdles for securing reimbursement for next-generation technology, Medtronic has slightly shifted its strategy to include partnering more closely with its hospital clients by offering greater breadth of products and services to help hospitals operate more efficiently. By partnering more closely and integrating itself into more hospital operations, Medtronic is well positioned to take advantage of more business opportunities in the value-based reimbursement environment, in our view. In particular, Medtronic has been pioneering risk-based contracting around some of its cardiac and diabetes products, which we think is attractive to hospital clients and payers alike.

We have always appreciated Medtronic's diverse portfolio, where certain waning product lines would be offset by growth in other categories. Management has recently taken a more active role in pruning the product portfolio with the intent to ramp up growth. The COVID-19 disruption added more near-term turbulence, especially with supply chain issues and delays in nonpandemic patient volume, but we remain confident that underlying demand for many of these therapies and Medtronic's ongoing innovation should prevail over the longer term.

Business Strategy & Outlook

Medtronic's wide moat is rooted in its dominant presence in highly engineered medical devices to treat chronic diseases, including those beyond its historical stronghold in heart disease. Medtronic's strongest moat source is intangible assets and to a lesser extent switching costs that are associated with specific products. 

In the cardiac area, Medtronic competes with roughly three competitors in total across its heart-related portfolio. The markets for pacemakers, ICDs, coronary stents, heart valves, and neuromodulation generally operate as rational oligopolies. There are some switching costs related to cardiac rhythm management devices and transcatheter aortic heart valves.

In the spine area, Medtronic's moat is strengthened by high switching costs for surgeons. Doctors often rely on medical-device sales reps for their deep device knowledge as well as their experience with device usage in a wide range of patients. As a result, Medtronic's reps play the role of highly specialized experts who advise practitioners on implantation, programming, and maintenance of Medtronic devices and create sticky relationships with medical practitioners. This dynamic tends to keep spinal surgeons loyal to Medtronic's products, as long as the company does not fall too far behind its competitors when it comes to introducing new technology. 

Finally, Medtronic's wide moat is bolstered by several intangibles, including intellectual property and carefully nurtured relationships with physicians. Thanks to its persistent ability to innovate, Medtronic is often first to market with new products in various therapeutic areas. We expect Medtronic to continue its record of innovation, based on its extensive patent portfolio. According to independent intellectual property evaluation publications Device Link and The Patent Board, Medtronic holds the strongest intellectual property position based on number and technological strength of its patents. 

We think Medtronic's diversified medical technology portfolio allows it to better weather occasional glitches in the development or approval process for any particular new device. Investments in neuromodulation, diabetes, and spinal products from the middle to late 1990s paid off in spades through 2010. Although the spine and ICD businesses have been hit with slower market growth since then, the firm has seen double-digit growth in its diabetes, surgical technologies, drug-coated balloons, neurovascular, and atrial fibrillation segments. While some of Medtronic's product lines have waned as new clinical data has altered treatment guidelines, the firm continues to invest in emerging technologies, including renal denervation and transcatheter mitral valves, that should drive future growth. 

The addition of Covidien deepened Medtronic's competitive advantages, as Covidien's medical-device segment enjoys brand recognition, technological innovation, and substantial scale. Most of Covidien's device subsegments operate in an oligopolistic fashion; the absence of irrational price competition and the evolutionary (rather than revolutionary) nature of innovation tend to lead to only marginal share shifts in the industry and strong excess returns. Covidien currently ranks at or near the top in all product categories where it competes in devices and vies mainly with Johnson & Johnson; the rest of the field is typically highly fragmented, with most companies occupying product niches rather than competing broadly against the big two. 

We have seen few new entrants making significant inroads. New competitors sometimes pop up on the margins, ranging from less sophisticated (discounted prices) to high-end (technological advancements), but they rarely result in monumental market shifts. The existing players' positioning is very defensible, with most practitioners rarely switching to competitors' products because of inertia as well as up-front training costs. While surgeons' influence over procurement decisions is arguably waning, the established players also have administrators' ears. 

In terms of environmental, social, and governance issues, Sustainalytics rates Medtronic's ESG risk at medium, and we concur. The risk profile is driven primarily by exposure to potential defects in life-sustaining products, such as cardiac rhythm management devices, insulin pumps, and heart valves. Some of this risk is mitigated by Medtronic's strong management measures.

As with other cardiac device makers, Medtronic has also weathered periodic product recalls, ensuing litigation, and ponied up funds to settle suits. However, we note none of the recalls we've observed in two decades has permanently damaged Medtronic's economic profits or its reputation with practitioners. There are several reasons for this. 

First, because device markets are relatively small, the pool of complainants usually numbers in the thousands or tens of thousands, not millions of people. This translates into settlements that are relatively small and manageable.

Second, device makers that rely on the FDA's premarket approval process are granted significant protection from legal liability on devices sold in the U.S. This counter-intuitive situation is the result of a confluence of factors, including how the 1976 Medical Device Amendments to the Food, Drug, and Cosmetic Act from 1938 that established the FDA were written (and further amended), and a series of cases that ran up to the Supreme Court. We estimate a significant proportion of Medtronic's products, including the life-saving Class III products, go through the premarket approval pathway. This also acts to largely limit the size of the settlements to the costs of ensuing medical care for affected patients.

Third, Medtronic's device product cycles are relatively short and product defects can often be addressed by the engineers. As a result, new products or even previous-generation products that have demonstrated their safety and efficacy can be marketed fairly quickly, saving some of the lost sales. We've seen this most recently with Medtronic's recall of its 600-series insulin pumps that had a defective retainer ring, but the firm was able to switch over to a different retainer ring as a replacement.

Wide

Economic Moat

Medtronic

Medtronic Plc is a medical technology company, which engages in the development, manufacture, distribution, and sale of device-based medical therapies and services. It operates through the following segments: Cardiovascular Porrtfolio, Neuroscience Portfolio, Medical Surgical Portfolio, and Diabetes Operating Unit. The Cardiovascular Portfolio segment includes products for the diagnosis, treatment, and management of cardiac rhythm disorders and cardiovascular disease. The Neuroscience Portfolio is made up of cranial and spinal technologies, specialty therapies, and neuromodulation divisions. The Medical Surgical Portfolio is comprised of surgical innovations and respiratory, gastrointestinal, and renal divisions. The Diabetes Group segment offers insulin pumps, continuous glucose monitoring systems, and insulin pump consumables. The company was founded in 1949 and is headquartered in Dublin, Ireland.

Earnings data Q1 2024

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Medtronic plc (NYSE:MDT ) Q2 2024 Earnings Conference Call November 21, 2023 8:00 AM ET Company Participants Ryan Weispfenning - Vice President and Head, Investor Relations Geoff Martha - Chairman and Chief Executive Officer Karen Parkhill - Chief Financial Officer Brad Welnick - Vice President, Investor Relations Laura Mauri - Senior Vice President and Chief Scientific, Medical, and Regulatory Officer Que Dallara - EVP and President, Diabetes Sean Salmon - EVP and President, Cardiovascular Portfolio Brett Wall - EVP and President, Neuroscience Portfolio Mike Marinaro - EVP and President, Surgical & Endoscopy Businesses Conference Call Participants Robbie Marcus - JPMorgan Travis Steed - Bank of America Larry Biegelsen - Wells Fargo Securities Vijay Kumar - Evercore ISI Kristen Stewart - CL King Matt O'Brien - Piper Sandler Rich Newitter - Truist Securities Shagun Singh - RBC Capital Markets Ryan Weispfenning Good morning. Welcome to a crisp fall morning here in Minnesota.

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