Plain Dividend Yield’s For Chumps: Dividend Growth at Medtronic 17% a Year

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Medical device manufacturer Medtronic (MDT) has pumped out 17% annualized dividend growth over the past five years. That ranks as the 7th strongest dividend growth among the S&P 500 Dividend Aristocrats -- companies that have managed to increase their annual dividend payout for at least 25 consecutive years.

This is part of series on the 10 Dividend Aristocrats with the highest dividend growth. Previous articles featured Clorox (CLX), T. Rowe Price (TROW) and Wal-Mart (WMT).

There’s plenty more room for more strong dividend growth going forward, as Medtronic’s dividend payout ratio and the cash dividend payout ratio are below 30%. Free cash flow has grown 22% over the five years. Cash on the books has more than doubled to $2.7 billion. Long-known for its heart devices, nearly half of Medtronic’s net sales in its 2012 fiscal year came from its non-cardio divisions, which includes therapies for diabetes and spinal injuries.

Yet the stock has badly lagged the market, as seen in a stock chart.

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MDT Chart

Adding in the dividend payout (the current dividend yield is 2.4%) Medtronic still has a -2% total return over the past five years, compared to the 17% advance for the S&P 500.

Part of the problem has been self-inflicted; in 2011 the company was hit with allegations of improper sales tactics for its Infuse spinal fusion therapy. Last year the company settled a shareholder lawsuit for $85 million and the Department of Justice closed an investigation without bringing any charges.

New pressure is coming from implementation of the Affordable Care Act. Beginning this year, most medical devices are subject to a 2.3% excise tax. Industry-wide that new levy is expected to raise $20 billion over 10 years to help offset costs of the ACA. Medtronic estimates its annual hit will be in the range of $125 million-$175 million after tax. At the higher end that’s about 5% of Medtronic’s net income from the past 12 months.

What isn’t suffering is Medtronic’s earnings per share, which has grown steadily since the recession. For the current fiscal year Medtronic’s guidance is for EPS growth of 6% to 7%.

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MDT PE Ratio TTM Chart

As the above chart shows, the stock’s valuation hasn’t followed the earnings growth. Medtronic needs a good-news catalyst. While the ACA excise tax is a drag, next year’s expansion of the insured could broaden Medtronic’s client base.

Foreign expansion is the big focus. While Medtronic’s 2012 fiscal year U.S. revenues were flat, net foreign sales climbed 12%, accounting for 45% of the company’s total net sales. That happens to coincide with when Medtronic installed a new CEO, Omar Ishrak. Prior to joining Medtronic he was at the center of GE Healthcare’s push into China. This past fall, Medtronic spent $755 million to acquire Chinese medical device manufacturer, China Kanghui Medical. Medtronic has $2.7 billion in cash on its books, so it wasn’t a financial stretch. But Medtronic has a checkered history with acquisitions; how this one plays out is an important wildcard. What’s more clear is that the dividend stream should keep flowing. Though perhaps not as strongly as the 17% five-year rate. Over the past one and three year periods, dividend growth was in the high single digits. That’s still strong, and about triple the rate of inflation.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

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