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Table of Contents
Introduction ................................................................................................................................................................1
Industry Competition ..............................................................................................................................................1
Ratio Analysis .............................................................................................................................................................2
ROE disaggregation into the operating and non-operating components .....................................2
ROE disaggregation using DuPont Model ..................................................................................................3
Short-term liquidity ............................................................................................................................................4
Capital structure and long-term solvency .................................................................................................5
Turnover analysis ................................................................................................................................................6
Common-size balance statement and income statement ....................................................................6
Investment analysis .................................................................................................................................................6
Solvency Ratios ................................................................................................................................................7
Cash Flow Analysis .........................................................................................................................................9
Capital Structure........................................................................................................................................... 10
LONG-TERM EQUITY INVESTMENT ......................................................................................................... 10
ROE..................................................................................................................................................................... 11
Stock Repurchase ......................................................................................................................................... 12
Total Shareholder Return ......................................................................................................................... 13
Cash Flows ...................................................................................................................................................... 13
Conclusion ................................................................................................................................................................ 15
Appendix A: Medtronic Financial Statements and Ratios ........................................................................1
Appendix B: St. Jude Financial Statements and Ratios ..............................................................................1
Appendix C: Competitors Analysis ....................................................................................................................1
Appendix D: Calculation of ROE disaggregation into operating and non-operating return ......3
Table of Tables
Table 1: Fiscal Year Definition.............................................................................................................................1
Table 2: ROE Disaggregation ...............................................................................................................................3
Table 3: ROE Disaggregation using DuPont Model .....................................................................................4
Table 4: Short Term Liquidity Ratios ...............................................................................................................4
Table 5: Capital Structure and Long-term Solvency Ratios.....................................................................5
Table 6: Turnover Analysis...................................................................................................................................6
Table 7: MDT Stock Repurchasing .................................................................................................................. 12
Table 8:
STJ Stock Repurchasing............................................................................................................... 13
Table 9: Cash Flows for MDT and STJ............................................................................................................ 14
Table 10: Free Cash Flows to the Firm for MDT and STJ ....................................................................... 14
Table of Figures
Figure 1: Stock Price Performance for MDT and STJ..11
Introduction
This financial accounting analysis is about Medtronic, Inc. (MDT) and St. Jude Medical (STJ),
two medical device companies. These two companies prepare the financial statements in
conformity with generally accepted accounting principles in the United States (GAAP). This
project report is mainly based on four years annual reports of these two companies. MDT
reports their financials in April of each year, whereas STJ reports in December/January. For the
purposes of this report each companys financial information will be stated in terms of fiscal
years according to Table 1.
Table 1: Fiscal Year Definition
MDT Reporting Date
Apr.26, 2012
Fiscal Year
Fiscal Year 4
Fiscal Year 3
Fiscal Year 2
Fiscal Year 1
The goal of this project is to make long-term debt and equity investment decisions based on the
financial analysis of the firm's operating performance, profitability, short-term liquidity, capital
structure and long-term solvency risks, and stability.
Industry Competition
Medical device industry is a highly competitive industry. This industry has been adversely
affected by financial crisis in the past four years, however, the inelasticity of medical service
demand, technology advances, and aging populations continue to bolster market growth. In
addition, recent healthcare reform and regulation have had complex impacts on the medical
device industry. For example, 2010 Obama Care includes subsidies and new taxes on medical
device manufacturers. Moreover, consolidation among health care providers and large
investment on advanced technology increase the competition on basis of price and drive
merger and acquisition within the industry.
MDT has a diversified business portfolio, operating three segments: Cardiac and Vascular
(including cardiac rhythm disease management (CRDM), coronary, structural heart, and
endovascular), Restorative Therapies (including spine, neuromodulation, and surgical
technologies), and Diabetes.
MDT faces competition from business such as large manufacturers with multiple business lines
to small manufacturers that offer a limited selection of products. MDT identified its competitors
in each division of its main products in its annual report. All the competitors in the each division
were examined and it was found that Boston Scientific, Johnson & Johnson, and STJ were the
main competitors in MDTs significant product divisions. See Appendix C.
For the purpose of this financial analysis, Johnson and Johnson was ruled out because of its
complex business structure. Medical devices and diagnostics only took up approximately 40% of
Johnson and Johnsons total sales, while pharmaceutical and consumer goods took up
approximately 60% of total sales in 2013. There was an insufficient breakdown of information
1
for an analysis and comparison to MDT of Johnson and Johnsons medical devices and
diagnostics segment.
It was found that STJ and Boston Scientific have very similar business as MDT. Boston
Scientifics stock price is only $13, while stock prices of both MDT and STJ are around $65,
which leads to the conclusion that STJ is more comparable with MDT.
STJ has two business divisions: implantable electronic systems division (which combines cardiac
rhythm management and neuromodulation) and the cardiovascular and ablation technologies
division (which combines cardiovascular and atrial fibrillation).
Compared with MDT, STJ has a smaller scale of sales revenue. The revenues of MDT are$15,508
$ 16,184, $16,590, $17,005 in fiscal year 1 to 4 respectively. Alternatively, the revenues of STJ
are $5,165, $5,612 ,$5,503, $5,501 in fiscal years 1 to 4 respectively.
Ratio Analysis
ROE disaggregation into the operating and non-operating components
As manufacturing companies, MDT and STJ highly rely on their operating activities. High
operating return indicated companies growth came form it operation of main business. When
calculating operating return for MDT, the following items should be specially noted as operating
or non-operating items:
Special charges, restricting charge, and litigation charge, acquisition-related items
Special charge in fiscal year 4 is $40 million charitable contribution should not be
considered as operating expense. Restructuring charge including employee termination
cost, inventory write-offs of discontinued products lines and production-related
impairment should be considered as operating expense. Litigation charge that is related
to patent should be included in operating expense. Acquisition-related items primarily
including IPR&D and long-lived asset impairment should be considered as operating
expense.
Other accrued expense and other long-term liabilities
MDT includes the warranty obligation, all derivatives, contingent consideration
associated with acquisitions, and litigation charge in other accrued expenses and other
long-term liabilities. Warranty obligation, contingent consideration associated with
acquisition and litigation charge should be considered as operation liabilities, while
derivatives should be classified as investment liabilities.
When calculating operating return for STJ, the following items should be specially noted as
operating or non-operating items:
Special charges:
Year 3
Year 2
Year 1
Average
0.1608
0.1938
0.1753
0.1949
(0.0144) (0.0011)
0.2187
0.1979
0.0208
0.2024
0.1971
0.0053
0.1939
0.1913
0.0026
0.1702
0.1393
0.0309
0.1869
0.1411
0.0458
0.2358
0.1492
0.0866
0.1921
0.1414
0.0508
0.1755
0.1358
0.0397
fluctuating expenses, including restructuring charges, certain litigation charges, and acquisitionrelated items. Restructuring charges and acquisition-related items reflect the trend of
acquisition and advanced technology in medical device manufacturing industry. MDT needed to
restructure some of its factories by paying employee termination compensation and cutting off
some products line due to change of techonlogies. Certain litigation charges gave investors a
sign of regulation risks because MDT paid extremely high amount of litigation charge ($ 770
millions) in fiscal year 4.
STJs profit margin and tax burden ratio were stable, but interest burden, financial leverage,
and asset turnover ratio decreased from fiscal years 1 to 4. Total short-term debt and long-term
debt increased significantly from years 1 to 4.
Table 3: ROE Disaggregation using DuPont Model
MDT
Profit Margin
Asset Turnover Ratio
Financial Leverage
ROE
STJ
Profit Margin
Asset Turnover Ratio
Financial Leverage
ROE
Year 4
Year 3
Year 2
Year 1
Average
0.180
0.467
1.910
0.161
0.209
0.490
1.890
0.194
0.223
0.510
1.920
0.219
0.200
0.528
1.920
0.202
0.203
0.499
1.910
0.194
0.131
0.564
2.297
0.170
0.137
0.602
2.133
0.176
0.147
0.639
1.986
0.187
0.176
0.689
1.948
0.236
0.148
0.623
2.091
0.192
Short-term liquidity
The short-term liquidity ratios for MDT and STJ are found in Table 4.
MDTs current ratio, quick ratio and cash ratios for four fiscal years are above 2, indicating that
MDT is able to pay off short-term debts due in the very near future and have enough money to
finance its day-to-day business operations.
For four fiscal years, STJs current ratio and quick ratio are above 2, but cash ratio is less than 1.
In fiscal year 1, the cash ratio was only 0.492. The low cash ratio indicated higher risk for STJ to
pay off its short-term debts in fiscal year 1 when cash was $500 million and current liability was
$1,017 million. Since STJ increased its sales and profit, cash and cash equivalent increased from
fiscal year 2 to 4. With the stable growth of operating income and cash, a cash ratio slightly less
than 1 does not mean STJ has a liquidity issue.
MDT has improved its cash conversion cycle significantly by encouraging customer to pay cash
earlier, selling inventory faster, and delaying payment to its suppliers. STJ did a good job to
improving inventory turnover rate. But since the purchasing power of customers is high and STJ
with smaller scale of business, STJ have to wait longer for cash payment on credit sales.
Table 4: Short Term Liquidity Ratios
Year 4
Year 3
Year 2
Year 1
Average
3.815
3.247
2.562
164
4.519
3.761
2.818
179
2.756
2.220
1.578
196
1.936
1.310
0.514
190
3.257
2.635
1.868
182
2.833
2.025
0.995
187
2.001
1.433
0.673
179
3.193
2.216
0.928
178
2.863
1.800
0.492
202
2.723
1.869
0.772
187
MDT
Current ratio
Quick ratio
Cash ratio
Cash conversion cycle
STJ
Current ratio
Quick ratio
Cash ratio
Cash conversion cycle
MDT
Debt-to-equity
Debt-to-capital
Debt-to-assets
Financial leverage
Interest coverage
STJ
Debt-to-equity
Debt-to-capital
Debt-to-assets
Financial leverage
Interest coverage
Year 4
Year 3
Year 2
Year 1
Average
0.951
0.488
0.488
1.951
10
0.869
0.465
0.465
1.869
11
0.918
0.479
0.479
1.918
12
0.921
0.479
0.479
1.921
9
0.915
0.478
0.478
1.915
11
1.327
0.570
0.570
2.327
9
1.265
0.558
0.558
2.265
10
1.012
0.503
0.503
2.012
12
0.960
0.490
0.490
1.960
14
1.141
0.530
0.530
2.141
11
Turnover analysis
MDT has higher A/R turnover ratio and lower A/P turnover ratio than STJ, which probably
because MDT has larger market share and stronger bargain power than STJ. MDT and STJ have
similar inventory turnover ratio, which indicate they both maintain proper inventory stock level.
The total asset turnover and working capital turnover for MDT are lower than those for STJ over
recent four fiscal years, while fixed asset turnover ratios for MDT is higher than STJ as shown in
Table 6. Lower turnover ratios indicate that MDT has less efficiency of operation for total asset
and working capital, more efficiency of operation for fixed assets. For the same amount of total
asset and working capital, MDT generated less revenue than STJ. For the same amount of fixed
asset, MDT generated more revenue than STJ.
Please find more detailed analysis as for turnover ratios in following discussion of Long-Term
Debt Investment.
Table 6: Turnover Analysis
MDT
Receivables Turnover
Inventory Turnover
Payables Turnover
Total asset turnover
Fixed asset turnover
Working capital turnover
STJ
Receivables Turnover
Inventory Turnover
Payables Turnover
Total asset turnover
Fixed asset turnover
Working capital turnover
Year 4
Year 3
Year 2
Year 1
Average
4.512
2.521
6.108
0.467
6.966
1.151
4.403
2.350
6.482
0.490
6.685
1.365
4.276
2.275
7.679
0.510
6.524
2.182
4.371
2.387
8.389
0.528
6.318
3.393
4.391
2.383
7.165
0.499
6.624
2.023
3.970
2.388
6.675
0.56
3.88
2.56
4.052
2.492
6.675
0.60
3.91
2.68
4.160
2.372
5.956
0.64
4.14
2.66
4.129
2.124
6.592
0.69
4.17
3.05
4.078
2.344
6.475
0.623
4.025
2.736
Investment analysis
LONG-TERM DEBT INVESTMENT
6
Based on the financial statement analysis performed on MDT and STJ, we are more inclined to
invest in the long-term debt of MDT for the following reasons:
1) Solvency ratios, both leverage and coverage, of MDT are generally better than STJ
2) Cash flow analysis (i.e., operating performance, financial flexibility, and liquidity) yields
better performance ratios from MDT, which reflect better ability to pay out interest and
long term obligations
3) Capital structure of MDT still permits growth for debt, a cheaper source of financing than
equity
Solvency Ratios
Leverage ratios of STJ are generally higher than those of MDT, which indicate that STJ is
financing its assets and operations by using more debt than equity.
Debt-to-Equity
Given its lower debt relative to equity, MDT is in a better position to pay off interests and other
debt obligations than STJ in the future. For its 4-year fiscal performance, STJ had an average
debt-to-equity ratio of 1.14 compared to 0.91 of MDT. From Fiscal Years 1 to 4, STJs total
liabilities have increased steadily driven mainly by the growth in its long-term debt from about
US$2.4 billion in year 1 to US$3.5 billion in year 4. As a percentage of total assets, STJs total
liabilities likewise grew from 49% in year 1 to 57% in year 4 as a result of higher debt financing
coupled with a slower growth in total assets. STJs long-term debt as a proportion of total
assets consequently increased from only 28% in year 1 to 34% in year 4. On the other hand,
while MDTs total liabilities have increased from fiscal Years 1 to 4, total assets grew at the
same pace of 8% on average, resulting to a relatively stable proportion of total liabilities to total
assets of about 48% for the 4-year period. Similarly, MDTs long-term debt rose from years 1 to
4 which helped the company pay off its other maturing short-term and long-term obligations as
well as finance its stock repurchase program.
Debt-to-Capital
Given its lower debt-to-capital ratio, MDT is a more attractive choice than STJ because the
former has lower default risk. For its 4-year fiscal performance, MDTs debt-to-capital ratio
averaged 0.48, lower than STJs 0.53 for the same period. A greater proportion of debt in total
capitalization meant increased likelihood of default risk for a company. Moreover, default risk
increased because of dividends payments. STJs equity was hurt more by paying out increasing
annual dividends beginning year 2 despite declining net income from years 1 to 4. Thus,
retained earnings decreased in year 3 and 4, and the proportion of debt to total capital
increased. While MDT posted back-to-back decline in net income in year 3 and4, its ability to
pay dividends was somehow buoyed by the companys strong cash flow from operations as well
as its short-term and long-term borrowings.
7
Debt-to-Assets
Given its lower debt-to-asset ratio, MDT is exposed to less default risk. Total debt-to-assets
ratio of STJ averaged 0.53 from year 1 to 4 compared to 0.48 of MDT for its 4-year fiscal
performance. In addition, total liabilities of STJ outpaced the growth of its total assets, which is
indicative of a deteriorating financial risk profile as the company needs more dollars to finance
one unit of asset. Thus, investing in MDTs long-term debt is still more desirable than STJ after
evaluating the debt-to-asset ratio.
On the other hand, the two firms coverage ratios reveal a more interesting pattern. While
financial leverage still supports the argument for investing in MDTs long-term debt, the
interest coverage ratio deserves a closer look into STJs financial performance.
Financial Leverage
Financial leverage measures the amount of assets that is supported by debt. A high leverage
indicates a higher degree of debt financing than equity. MDTs financial leverage was almost
steady throughout its 4-year reporting period ranging from 1.87 to 1.95, or about 1.91 on
average. STJs financial leverage, on the other hand, was higher and ranged between 1.96 and
2.33 for an average of 2.14 from years 1 to 4. Being a more leveraged company, STJ faces
greater default risk compared to MDT. Thus, investing in the long-term debt of MDT is still
preferable.
Interest Coverage
Interest coverage ratio measures the companys ability to meet its interest obligations. STJ
seemed to be paying lower interest on their loans than MDT, hence, the former had higher
interest coverage ratio for its 4-year reporting period. STJs interest expense as a percentage of
revenues was stable at 1% from years 1 to 4, while MDTs interest expense as a share of
revenues ranged from 2% to 3% from years 1 to 4. One possible reason for low interest
payments would be because in absolute amounts, STJ has lower long-term debt compared to
MDT. However, as the leverage ratios have shown, STJ is more exposed to default risk because
of its higher debt proportion relative to equity compared to MDT. In addition, MDT recorded
litigation charges for some of its patent settlement agreements that comprised about 2% of
sales on average for its 4-year reporting period. These charges even increased sharply in the
fourth year and accounted for 5% of sales. While these expenses hurt EBIT and consequently
the interest coverage ratio, they were non-cash in nature and were only provisions recorded to
account for probable liabilities or charges in the future, and therefore, should not really affect
MDTs capacity to pay its interest obligations. Thus, despite a lower interest coverage ratio,
MDTs long-term debt would still be attractive for an investor because of its overall ability to
pay long-term obligations given strong cash flows generated from operations and lower debt
financing as a percentage of total capitalization.
8
likely to cover and meet its interest and debt obligations. Given its strong cash flows from
operations, MDT is still preferred for a long-term debt investment.
Financial Flexibility
MDT also has easy access to other credit facilities. Its commercial paper program allows the
company to have $2.25 billion in commercial paper outstanding with maturities up to 364 days
from the date of issuance, but as of fiscal year 3, MDT has only $125 million of outstanding
commercial paper. MDT also has a $2.25 billion syndicated loan facility to provide backup
funding for its commercial paper program and for general use in operations. As of the most
recent reporting period, MDT has no outstanding amounts on the committed line of credit.
While STJ also has its own commercial paper program and credit facility to finance its shortterm and long-term funding requirements, MDTs stronger cash flows and healthier cash
balances place the company in a better position to pay off short-term and long-term obligations.
Moreover, STJ had issued foreign currency-denominated notes that again exposed the company
to foreign exchange risk, which could eventually hurt its cash flows and its ability to meet other
obligations.
Liquidity
As mentioned above, MDT has better management of working capital. Cash conversion cycle of
MDT improved, while STJs was more irregular and deteriorated in the fourth year. Liquidity
ratios of MDT are also better than those of STJ given the formers healthy cash balances and
substantial liquid investment portfolio, and better management of accounts receivable and
inventory levels. Given its ability to convert liquid assets into cash, coupled with strong cash
coming from operations, MDT is again more positioned to issue debt and meet interest and
principal payments.
Capital Structure
As discussed in the previous two sections, MDTs debt-to-total capitalization ratio is only about
0.48 for its 4-year reporting period. MDT utilizes equity more than debt in financing its
operations. Equity is more expensive to maintain than debt given the costs associated in issuing
new shares, transaction fees for share repurchases, and dividend payments to shareholders.
Given MDTs healthy cash flows from operations, substantial cash balances, and liquid
investment portfolio, the company still has room to increase its leverage by issuing long-term
debt without necessarily weakening its financial risk profile.
By raising capital through debt issuance, MDT will also get tax shields from the interest
payments, as well as improve its ROE.
LONG-TERM EQUITY INVESTMENT
While the figure 2 below easily shows that STJ stock has been outperforming MDT stock on a 4year period, a closer look at the financial performance of both companies provides a better
10
view of the drivers of the share price growth. After performing financial analysis, we have
decided to invest long-term in MDTs stock for the following reasons:
1) STJs ROE has been declining for 3 years given decreasing profitability
2) Stock repurchase is a good strategy to maximize return to shareholders, but between MDT
and STJ, MDT is in a better position because of its stronger cash flows
3) Comparison of total shareholder return somehow provides better trend in MDT stock
investment than STJ
4) Value of company will still depend on its ability to generate cash; MDT generates stronger
cash flows from operations and is in a better position to support share price growth through
dividend payouts and share repurchase than STJ
5) Upside for MDT stock price growth: excess cash may be used to pay dividends, continue
with stock repurchase program, or acquire companies to increase leverage and take
advantage of its benefits; improved leverage provides higher ROE and maximizes
shareholder return
Figure 1: Stock Price Performance for MDT and STJ
200.00
180.00
160.00
140.00
120.00
100.00
80.00
60.00
40.00
MDT
STJ
20.00
1/4/2010
1/4/2011
1/4/2012
1/4/2013
1/4/2014
ROE
STJs ROE has been under pressure for the past 3 years because of decreasing net income.
Coming off a year with high profitability, STJ decided to pay out dividends in year 2 in addition
to its stock repurchase program to further maximize shareholder return. Unfortunately, net
income dropped in year 2 which somehow hurt the companys ability to pay out dividends. In
order to maximize shareholder return, STJ continued to pay dividends that even increased in
the next 2 years, albeit at a decreasing annual rate. With net income declining, lower earnings
were plowed back to the business. On the other hand, while MDTs net income also declined in
11
its most recent 2 fiscal years, MDTs ability to pay out dividends was not really affected because
of its strong operating cash flows. MDTs ROE in the latest fiscal year, however, stood lower
than STJ as the formers net income declined faster than STJs. Despite this, MDT still had a
generally higher ROE than STJ if previous years results were taken into account. In addition,
MDT still has potential to improve its ROE by increasing leverage. Thus, return to stockholders
still has an upside when investing in MDT stock.
Stock Repurchase
Stock repurchase is a good way to support a firms share price, especially in times when the
market is not doing well and management sees that its share is undervalued. Stock repurchase
is also a form of return to shareholders, sometimes used as a substitute to dividends. MDT and
STJ implemented a stock repurchase program aside from paying out dividends. Thus, both
companies had good strategies of maximizing shareholder return. However, given MDTs
stronger ability to generate cash flows, it is in a better position to sustain both dividend payouts
and stock repurchase than STJ. Another effect of stock repurchase is increasing the companys
EPS, thereby creating incentive to own the companys share. A high EPS also leads to a lower
P/E ratio. A low P/E ratio compared to industry or competition means that the stock is
somehow undervalued and thus, also provides incentive to buy the stock. A high P/E ratio
compared to industry or competition, on the other hand, might signal that the companys stock
is overvalued. For MDT and STJ, a quick-and-dirty computation shows that P/E ratios of MDT
are lower than those of STJ. This means that MDT stock still has room to increase in value and
be at par with competition. On the other hand, STJ stock might be a little overvalued given its
lower operating margins, the downtrend in its profitability and its lower cash flows relative to
MDT. For these reasons, investing long-term in MDT stock is preferable as it provides
opportunity for capital appreciation, which is supported by higher operating and net profit
margins, and strong cash flows from operations.
Table 7: MDT Stock Repurchasing
MDT
Beginning price
Ending price
Dividends per share
Capital Gain
Dividend Yield
Total Shareholder Return
Dividend growth
Dividend payout
2010
43.90
37.09
0.8800
-16%
2%
-14%
2011
37.41
38.25
0.9525
2%
3%
5%
2012
38.69
41.02
1.0225
6%
3%
9%
2013
41.88
57.39
1.1000
37%
3%
40%
2014*
57.24
68.70
1.1950
20%
2%
22%
8%
31%
7%
33%
8%
29%
9%
32%
EPS, diluted
2.79
2.86
3.41
3.37
P/E, using YE price
13.29
13.37
12.03
17.03
*Ending price on 11/5/14; dividends per share include last payout for the year
12
STJ
Beginning price
Ending price
Dividends per share
Capital Gain
Dividend Yield
Total Shareholder Return
Dividend growth
Dividend payout
2010
37.03
42.75
15%
0%
15%
2011
42.28
34.30
0.8400
-19%
2%
-17%
2012
34.93
36.14
0.9200
3%
3%
6%
2013
36.61
61.95
1.0000
69%
3%
72%
2014*
61.71
65.22
1.0800
6%
2%
7%
10%
34%
9%
38%
8%
23%
EPS, diluted
2.75
2.52
2.39
2.49
P/E, using YE price
15.55
13.61
15.12
24.88
*Ending price on 11/5/14; dividends per share include last payout for the year
percentage of sales to measure the level of cash flows generated for each dollar of sales. On
average, MDT has stronger cash flows with about 28% of total sales in its 4-year reporting
period than STJ, which has CFO-to-sales ratio of about 22% for its past 4 fiscal periods. Since
MDT is able to generate heathier cash flows than STJ, the former is also in a much better
position to cover its capital expenditures as shown by the CFO-to-capex ratio. CFO-to-capex
ratio of STJ is below 5.0, while MDTs ratio ranges from about 7.5 to 12.5.
Table 9: Cash Flows for MDT and STJ
2010
Sales (in US$ Mn)
MDT
STJ
Additions to PPE (in US$ Mn)
MDT
STJ
Capex-to-Sales (%)
MDT
STJ
CFO (in US$ Mn)
MDT
STJ
CFO-to-Sales
MDT
STJ
CFO-to-Capex (x)
MDT
STJ
2011
2012
2013
2014
15,508
5,612
16,184
5,503
16,590
5,501
17,005
5,165
501
307
484
280
457
222
396
305
3%
5%
3%
4%
2%
6%
3%
5%
3,741
1,287
4,470
1,335
4,942
961
4,959
1,274
24%
23%
28%
24%
30%
17%
29%
25%
7.47
4.19
9.24
4.77
10.81
4.33
12.52
4.18
Another way to look at a companys ability to generate cash flows that will be available for both
its equity and debt investors is by measuring the free cash flows to the firm (FCFF). A quickand-dirty estimation of the FCFF still shows that MDT has an advantage over STJ. Since at the
end of the day the level of FCFF will determine the value of the company, MDT stock is more
attractive than STJ stock.
Table 10: Free Cash Flows to the Firm for MDT and STJ
14
2010
1,274
67
44
305
1,013
2011
3,741
450
293
501
3,533
2012
4,470
349
227
484
4,213
2013
4,942
388
252
457
4,737
1,287
70
46
307
1,026
1,335
73
47
280
1,102
961
81
53
222
792
2014
4,959
379
246
396
4,809
Further, STJ has a greater financial risk profile than MDT given its higher leverage in addition to
the pressure on operating and net profit margins, and thus, will also have a higher cost of
capital. A higher cost of capital generates a lower valuation of a company given its FCFF. From
the FCFF standpoint, MDT stock is still more valuable than STJ stock.
Upside for MDT Share Price Growth
Since MDT has substantial cash balances, a sizable investment portfolio given its large
investments in marketable securities, and strong cash flows from operations, MDT has flexibility
to maximize shareholder value. Excess cash may be used to pay out dividends for as long as net
income permits. In fact, MDT may even consider increasing its dividend payout ratio which
now stands at approximately 31% of prior years net income. Alternatively, MDT may continue
its share repurchase program and pay shareholders a premium over market to utilize excess
cash and maximize return to shareholders. Stock repurchase might also be a good strategy to
support the companys stock when the market is bad, or as an additional return to shareholders
when net income is not performing well. Buying back shares will generally increase EPS and
reduce P/E ratios, and thus, will make the companys stock more competitive in the market.
Finally, MDT can use its excess cash to acquire companies and increase its leverage. A higher
leverage will allow MDT to take advantage of its benefits such as tax shields and a higher ROE,
which will definitely maximize shareholder return. Thus, for a long-term investment in equity,
MDT still has advantage over STJ given the upside potential for share price growth and returns
from dividends or share repurchase.
Conclusion
MDTs ability to generate strong cash flows will allow the company to source financing either
through debt or equity. MDT is financially strong and has the capacity to meet short-term and
long-term debt obligations as displayed by the calculated financial metrics and measured
against competition. Since it has low leverage, MDT has the option of raising capital through
debt issuance and in turn, optimizes its debt-to-equity ratio. Alternatively, MDT can pursue its
acquisition plans to increase leverage and still improve its capital structure. By carrying out
either method, MDT will be able to maximize shareholder return.
15
April
25,
2014
April
26,
2013
April
26,
2012
April
26,
2011
1,403
919
1,172
1,382
3.7%
2.6%
3.6%
4.5%
12,838
3,811
1,725
736
697
10,211
3,727
1,712
539
744
8,178
3,808
1,800
703
675
1,046
3,761
1,619
523
561
258
33.8%
10.0%
4.5%
1.9%
1.8%
29.3%
10.7%
4.9%
1.5%
2.1%
24.9%
11.6%
5.5%
2.1%
2.1%
3.4%
12.3%
5.3%
1.7%
1.8%
21,210
17,852
16,336
9,150
55.9%
51.2%
49.8%
29.8%
2,392
2,490
2,473
2,488
6.3%
7.1%
7.5%
8.1%
Goodwill
10,593
10,329
9,934
9,520
27.9%
29.6%
30.3%
31.0%
2,286
2,673
2,647
6.0%
7.7%
8.1%
300
1,162
232
1,324
176
1,252
2,725
6,116
314
362
0.8%
3.1%
0.7%
3.8%
0.5%
3.8%
8.9%
19.9%
1.0%
1.2%
37,943
34,900
32,818
30,675
100.0%
100.0%
100.0%
100.0%
1,613
742
1,015
164
19
2,006
910
681
1,011
88
16
1,244
3,274
565
912
154
14
1,008
1,723
495
874
50
7
1,489
88
4.3%
2.0%
2.7%
0.4%
0.1%
5.3%
2.6%
2.0%
2.9%
0.3%
0.0%
3.6%
10.0%
1.7%
2.8%
0.5%
0.0%
3.1%
5.6%
1.6%
2.8%
0.2%
0.0%
4.9%
0.3%
5,559
3,950
5,927
4,726
14.7%
11.3%
18.1%
15.4%
10,315
662
9,741
752
7,359
759
8,112
480
27.2%
1.7%
27.9%
2.2%
22.4%
2.3%
26.4%
1.6%
1,343
386
235
1,168
340
278
1,005
276
379
496
461
432
3.5%
1.0%
0.6%
3.3%
1.0%
0.8%
3.1%
0.8%
1.2%
1.6%
1.5%
1.4%
18,500
16,229
15,705
14,707
48.8%
46.5%
47.9%
47.9%
100
102
104
107
0.3%
0.3%
0.3%
0.3%
19,940
(597)
19,061
(492)
17,482
(473)
16,085
(224)
52.6%
-1.6%
54.6%
-1.4%
53.3%
-1.4%
52.4%
-0.7%
19,443
18,671
17,113
15,968
51.2%
53.5%
52.1%
52.1%
37,943
34,900
32,818
30,675
100.0%
100.0%
100.0%
100.0%
Total assets
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Short-term borrowings
Accounts payable
Accrued compensation
Accrued income taxes
Deferred tax liabilities
Other accrued expenses
Liabilities held for sale
Total current liabilities
Long-term debt
Long-term accrued compensation and retirement
benefits
Long-term accrued income taxes
Long-term deferred tax liabilities
Other long-term liabilities
Total liabilities
Commitments and contingencies (Notes 4, 15, and 18)
Shareholders equity:
Preferred stock par value $1.00; 2.5 million shares
authorized, none outstanding
Common stock par value $0.10; 1.6 billion shares
authorized
Retained earnings
Accumulated other comprehensive loss
Fiscal Year
2014
2013
2012
2011
2010
2013
2012
2011
2010
Net sales
17,005
16,590
16,184
15,508
15,392
100.0%
100.0%
100.0%
100.0%
100.0%
4,333
4,126
3,889
3,700
3,582
25.5%
24.9%
24.0%
23.9%
23.3%
Gross Profit
12,672
12,464
12,295
11,808
11,810
74.5%
75.1%
76.0%
76.1%
76.7%
74.50%
75.10%
76.00%
76.10%
76.70%
1,477
1,557
1,490
1,472
1,424
8.7%
9.4%
9.2%
9.5%
9.3%
5,847
5,698
5,623
5,427
5,282
34.4%
34.3%
34.7%
35.0%
34.3%
EXPENSES
expense
Special charges
40
0.2%
78
172
87
259
50
0.5%
1.0%
0.5%
1.7%
0.3%
770
245
90
245
374
4.5%
1.5%
0.6%
1.6%
2.4%
Acquisition-related items
117
(49)
12
14
23
0.7%
-0.3%
0.1%
0.1%
0.1%
349
331
335
339
317
2.1%
2.0%
2.1%
2.2%
2.1%
181
108
364
110
150
1.1%
0.7%
2.2%
0.7%
1.0%
108
151
149
278
246
0.6%
0.9%
0.9%
1.8%
1.6%
Total Expenses
8,967
8,213
8,150
8,144
7,866
52.7%
49.5%
50.4%
52.5%
51.1%
3,705
4,251
4,145
3,664
3,944
21.8%
25.6%
25.6%
23.6%
25.6%
640
784
730
609
861
3.8%
4.7%
4.5%
3.9%
5.6%
3,065
3,467
3,415
3,055
3,083
18.0%
20.9%
21.1%
19.7%
20.0%
202
41
16
1.2%
0.3%
0.1%
3,617
3,096
3,099
22.3%
20.0%
20.1%
income taxes
3,065
3,467
18.0%
20.9%
28
Dec
2012
29
Dec
2011
31
Jan
2011
Jan
2010
Dec 28
2013
Dec 29
2012
Dec 31
2011
Jan
2011
Jan
2010
ASSETS
Current Assets
Cash and cash equivalents
1,373
1,194
986
500
393
13%
13%
11%
6%
6%
1,349
1,367
1,331
1,171
14%
15%
15%
16%
18%
Inventories
708
610
624
668
660
7%
7%
7%
8%
10%
229
220
232
197
165
2%
2%
3%
2%
3%
178
178
181
216
172
2%
2%
2%
3%
3%
3,910
3,551
3,391
2,912
2,560
38%
38%
38%
34%
40%
0%
0%
0%
0%
0%
651
602
528
494
424
6%
6%
6%
6%
7%
1,674
1,603
1,546
1,378
1,189
16%
17%
17%
16%
18%
Diagnostic equipment
474
424
380
353
336
5%
5%
4%
4%
5%
2,799
2,629
2,454
2,224
1,949
27%
28%
27%
26%
30%
(1,389)
(1,204)
(1,065)
(900)
(796)
-14%
-13%
-12%
-11%
-12%
1,410
1,425
1,388
1,324
1,153
14%
15%
15%
15%
18%
Goodwill
3,524
2,961
2,953
2,956
2,006
34%
32%
33%
35%
31%
911
804
856
987
456
9%
9%
10%
12%
7%
Other assets
493
530
417
388
251
5%
6%
5%
5%
4%
TOTAL ASSETS
10,248
9,271
9,005
8,566
6,426
100%
100%
100%
100%
100%
62
530
83
80
335
1%
6%
1%
1%
5%
Accounts payable
247
254
202
298
133
2%
3%
2%
3%
2%
Dividends payable
72
68
67
13
1%
1%
1%
0%
0%
32
142
0%
2%
0%
0%
0%
312
299
305
320
269
3%
3%
3%
4%
4%
655
482
402
320
317
6%
5%
4%
4%
5%
1,380
1,775
1,062
1,017
1,067
13%
19%
12%
12%
17%
Long-term debt
3,518
2,550
2,713
2,432
1,588
34%
28%
30%
28%
25%
240
323
279
311
132
2%
3%
3%
4%
2%
Other liabilities
706
529
477
435
315
7%
6%
5%
5%
5%
5,844
5,177
4,531
4,195
3,102
57%
56%
50%
49%
48%
0%
0%
0%
0%
0%
LIABILITIES
AND
EQUITY
Current Liabilities
SHAREHOLDERS'
Total liabilities
Shareholders' Equity
Common
stock
($0.10
par
value;
500,000,000 shares authorized; 289,117,352
and
295,648,327
shares
authorized;
289,117,352 and 295,648,327 shares
December 29, 2012, respectively)
Additional paid-in capital
29
220
30
-
32
43
33
156
32
6
0%
2%
0%
0%
0%
0%
0%
2%
1%
0%
Retained earnings
3,936
4,018
4,384
4,099
3,191
38%
43%
49%
48%
50%
46
46
16
84
94
0%
0%
0%
1%
1%
Total
shareholders'
noncontrolling interest
4,231
4,094
4,475
4,372
3,285
41%
44%
50%
51%
51%
173
38
2%
0%
0%
0%
1%
Noncontrolling interest
equity
before
AND
4,404
4,094
4,475
4,372
3,324
43%
44%
50%
51%
52%
$10,248
$9,271
$9,005
$8,566
$6,426
100%
100%
100%
100%
100%
St. Jude Medical Inc. Income and Common Size Income Statements
CONSOLIDATED STATEMENTS OF EARNINGS
Dec
28
2013
5,501
Dec 29
2013
Dec 31
2011
Jan 1
2011
Jan 2
2010
5,503
5,612
5,165
1,529
1,445
1,485
Special charges
45
93
1,574
Net sales
Dec
29
2013
100%
Dec
31
2011
100%
Jan 1
2011
Jan 2
2010
4,681
Dec
28
2013
100%
100%
100%
1,382
1,220
27.8%
26%
26%
27%
26%
47
28
34
0.8%
2%
1%
1%
1%
1,538
1,532
1,410
1,253
28.6%
28%
27%
27%
27%
Cost of sales:
3,927
3,965
4,079
3,755
3,428
71.4%
72%
73%
73%
73%
Gross profit
1,884
1,891
2,085
1,818
1,675
34.2%
34%
37%
35%
36%
691
676
705
631
560
12.6%
12%
13%
12%
12%
12
0.0%
0%
0%
0%
0%
Special charges
301
298
171
17
74
5.5%
5%
3%
0%
2%
1,051
1,100
1,114
1,277
1,113
19.1%
20%
20%
25%
24%
267
95
(95)
(68)
(56)
4.9%
2%
-2%
-1%
-1%
784
1,005
1,019
1209
1057
14.3%
18%
18%
23%
23%
92
253
193
301
280
1.7%
5%
3%
6%
6%
692
752
826
907
777
12.6%
14%
15%
16%
17%
(31)
-0.6%
Net earnings
723
752
827
907
777
13.1%
14%
15%
18%
17%
Basic
2.52
2.40
2.55
2.76
2.28
0.0%
0%
0%
0%
0%
Diluted
2.49
2.39
2.52
2.75
2.26
0.0%
0%
0%
0%
0%
1.00
0.92
0.84
0.0%
0%
0%
0%
Basic
287
313
324
328
328
5.2%
6%
6%
6%
7%
Diluted
291
315
327
330
344
5.3%
6%
6%
6%
7%
Operating profit
Other expense, net
Earnings before income taxes and noncontrolling interest
Neuromodulation
Spine
Endovascular
Structural Heart
Coronary
CRDM
Diabetes
9%
9%
10%
30%
20%
10%
7%
5%
In each product division, MDT identified its competitors shown in the table 11. Because
each division takes up to different proportion of net sales, we assign the same weight as
the percentage of net sale for each competitor. Some competitors such as Johnson and
Johnson, St. Jude are identified as competitors in multiple product divisions. We then
sum up the weight for each competitor. The total weight of competitors is shown in
Table 12. Boston Scientific, Johnson & Johnson, and St. Jude are the top three
competitors.
Produt
CRDM
Coronry
Structual
Heart
Endovascu
lar
% of net
sales
30%
10%
7%
5%
Competitors
Weight
30%
Sum of Weight
Boston Scientific
30%
Competitors
Biotrnik
30%
Abbott
15%
Sorin Group
30%
Allergan
11%
Abbott
10%
Alphatec Holdings
20%
Boston Scientific
10%
Arthrocare
Neuromo
dulation
Diabetes
Surgical
Tehnologi
es
20%
11%
9%
9%
Total
9%
Edwards Lifesciences
7%
Biomet
20%
7%
Biotrnik
30%
Sorin
7%
Boston Scientific
56%
7%
BrainLAB
9%
7%
Cook. Inc
5%
Abbott
5%
Coridien PLC
9%
Boston Scientific
5%
CR Boird
5%
DePuySynthes
CR Boird
5%
DexCom
9%
Cook. Inc
5%
Edwards Lifesciences
7%
5%
Endologix
5%
Endologix
Spine
Table 12.
5%
20%
5%
G.E.Healthcare
9%
DePuySynthes
20%
Globus Medical
20%
Stryker
20%
Gyrus ACMI
9%
Na Vasive
20%
Insulet
9%
20%
Globus Medical
20%
Zimmer Holdings
20%
Alphatec Holdings
20%
Na Vasive
20%
Orthafix International
20%
Orthafix International
20%
Biomet
20%
Philips Medical
9%
Boston Scientific
11%
Roche
9%
Allergan
11%
Siencens Medical
9%
11%
Sorin
Urologix
11%
Sorin Group
30%
48%
9%
43%
7%
7%
9%
DexCom
9%
Stryker
9%
Insulet
9%
Stryker
20%
Roche
9%
Tandem Diabetes
9%
Tandem Diabetes
9%
7%
9%
Urologix
Gyrus ACMI
9%
Stryker
9%
Zimmer Holdings
Zimmer Holdings
9%
9%
BrainLAB
9%
G.E.Healthcare
9%
Siencens Medical
9%
Philips Medical
9%
Coridien PLC
9%
Arthrocare
9%
11%
5%
29%
YR 4
3,773
YR 3
4,402
YR2
4,294
YR 1
3,942
640
784
730
609
38
3,095
53
3,565
52
3,512
97
3,236
Operating Assets
Accounts receivable, less allowances
Inventories
Tax assets
Prepaid expenses and other current
assets
Property, plant, and equipment, net
Goodwill
Other intangible assets, net
Long-term investments
Long-term deferred tax assets, net
Other assets
Total Operating Assets
Operating Liabilities
Accounts payable
Accrued compensation
Accrued income taxes
Deferred tax liabilities
Other accrued expenses
Long-term accrued compensation
and retirement
Long-term accrued income taxes
Long-term deferred tax liabilities
Other long-term liabilities
Total Operating Liabilities
Net Operating Assets
3,811
1,725
736
3,727
1,712
539
3,808
1,800
703
3,761
1,619
523
3,335
1,481
544
697
2,392
10,593
2,286
300
1,162
23,702
744
2,490
10,329
2,673
232
1,324
23,770
675
2,473
9,934
2,647
176
1,252
23,468
561
2,488
9,520
2,725
6,116
314
362
21,873
704
2,421
8,391
2,559
4,632
248
19,683
742
1,015
164
19
2,006
681
1,011
88
16
1,244
565
912
154
14
1,008
495
874
50
7
1,489
420
1,001
235
890
662
1,343
386
235
6,572
17,130
752
1,168
340
278
5,578
18,192
759
1,005
276
379
5,072
18,396
480
496
461
432
4,784
17,089
516
595
89
196
3,942
15,741
STJ
NOPAT COMPUTATION
EBIT
Income tax expense
Tax shield (interest
expense x statutory tax
rate of 35%)
NOPAT
YR 4
YR 3
YR2
YR1
1,051
1,100
1,114
1,277
92
253
193
301
28
26
25
23
931
821
896
952
Operating Assets
Accounts receivable, less allowance for
doubtful accounts
1,422
1,349
1,367
1,331
1,171
Inventories
708
610
624
668
660
229
220
232
197
165
178
178
181
216
172
1,410
1,425
1,388
1,324
1,153
3,524
2,961
2,953
2,956
2,006
911
804
856
987
456
Other assets
493
530
417
388
251
8,875
8,077
8,019
8,066
6,033
247
254
202
298
133
32
142
312
299
305
320
269
655
482
402
320
317
240
323
279
311
132
Other liabilities
706
529
477
435
315
2,192
2,029
1,667
1,683
1,166
6,683
6048
6352.601
6382.938
3965.25