I like the health care sector. A lot.
There is always a need for quality medicine and medical care, no matter how the economy is doing. And they hold defensive stocks that can weather ups and downs nicely.
As populations age in developed countries, health care will gain in importance. And as emerging markets adopt modern medical practices, the use of low-cost, high-volume health care products will ramp up. The sector could face unprecedented demand.
In the health-care sector, one of my favorites is Covidien PLC (COV). Of the 87 firms in the advanced medical equipment industry, it is among the 11 companies that pay a dividend.
The company develops, makes and sells medical devices, pharmaceuticals and medical supplies. Here are a few reasons why I love this stock:
1. Exciting products
Covidien has launched some great products: For example, the Sonicision, introduced in 2012, is an ultrasonic dissection device for surgical procedures.
Covidien has been expanding its product line through acquisitions and strategic collaborations. One successful launch has been the ADHD medication Concerta, which is expected to generate about $100 million in sales this year. This product received U.S. Food and Drug Administration (FDA) approval in December 2012.
2. Robust growth
Covidien's steady acquisition of companies has delivered solid growth in recent years.
In 2012, it acquired Maya Medical, Newport Corp., BARRX Medical, SuperDimension, Oridion Systems and MindFrame Inc. to expand its medical devices portfolio. It acquired CNS Therapeutics last year to expand its branded pharmaceuticals portfolio. The company also acquired CV Ingenuity to build its vascular segment. Collaborative and promotion agreements have also been signed.
3. Expected growth
As an example, Covidien is launching a study on bariatric procedures for treating Type 2 diabetes in patients with a body mass index less than 35, potentially affecting 5 million people.
4. Expanding markets
Emerging markets offer a sizable and rather underpenetrated marketplace for the company.
Covidien is launching products in various emerging markets, notably in Asia and Latin America. The company's sales in the BRIC nations -- especially China and Brazil -- are growing at a healthy pace. It plans to double its current $1 billion in revenue from emerging markets in the next five years, positioning it as a top medical instruments player in that market.
Take a look at the stock's recent success since the beginning of 2012:
On Jan. 25, Covidien reported adjusted earnings per share of $1.10 for the first quarter of fiscal 2013, 3 cents lower than the same period the previous year. Its net income was flat year-over-year at $493 million ($1.03 per share) due to higher expenses, which dampened otherwise solid sales growth. First-quarter revenue increased 5% year-over-year to $3 billion, driven mainly by higher sales in the medical devices segment. Gross margin was down slightly in the 2012 fourth quarter -- from 58.8% year over year to 57.5% -- mainly due to unfavorable currency fluctuations.
The stock is undervalued. With a current price of $67.84, the stock should be trading for at least $75 per share -- compare its forward price-to-earnings (P/E) ratio of 13.1 with the industry average of 25.2. Additionally, its operating earnings yield of 6.3% ranks higher than two-thirds of all stocks.
Covidien should see solid growth during the next three to five years. Its core device business should grow on average by at least 5% to 6% for the next five years. This should be fueled by its energy-based vascular devices, which can be expected to experience annual growth in the 10% to 12% range.
The stock has great momentum. On March 28, the stock closed at $67.84, which was just 0.2% below its 52-week high and 35% above its 52-week low. Shares are trading 6.3% above their 50-day moving average of $63.80, as well as 16.1% above their 200-day moving average of $58.41.
Covidien also has a healthy balance sheet and pays a solid dividend of 1.4%. Additionally, it buys back shares. Given its strong cash flow from operations, it should be able to maintain its current cash position, allowing it to grow through acquisitions.
Risks to consider: Strong competitors like Johnson & Johnson (JNJ) and Applied Medical have cut into market share in its soft tissue, endomechanical and commoditized trocar product line. With the changing regulatory environment in the United States, R&D costs are expected to increase substantially to meet more stringent approval requirements.
Action to take --> Covidien is a good buy up to $75 a share. My 12- to 18-month price target is $100, representing a 30% rise from its current price. With a current dividend of 1.4%, this stock provides a great combination of growth and income.
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