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Mixed 3Q for Covidien, Profit Drops

Zacks Equity Research

Covidien plc (COV), a large-cap medical technology company, reported its adjusted earnings per share (from continuing operations) of $1.07 for the third quarter of fiscal 2012, a penny above the Zacks Consensus Estimate and 6 cents higher than the year-ago quarter earnings. Adjusted earnings exclude one-time items and extraordinary charges.

Profits from continuing operations decreased 15% to $453 million (or 93 cents a share) due to higher income tax-related expenses and currency fluctuations.


Revenues for the third quarter of 2012 rose 3% year over year to $3,007 million. However, sales were lower than the Zacks Consensus Estimate of $3,012 million. Currency exchange rate negatively impacted quarterly revenue by 3%.

On a geographic basis, revenues in the U.S. market rose 6% to $1,680 million while international sales dropped 1% to $1,327 million. Strengthening U.S. dollar and a soft European economy affected international sales in the quarter. However, excellent revenues from emerging markets contributed positively to top-line growth.

Segment Analysis

Revenues from the larger Medical Devices segment increased 4% year over year to $2,063 million, driven by double-digit growth across Vascular and Energy Devices product lines. New products and higher volume contributed to growth.   

Within Medical Devices, revenues from Endomechanical Instruments increased 1% to $600 million helped by stapling products (including Tri-Staple). Revenues from Energy Devices soared 10% to $330 million boosted by strong vessel sealing sales. Sales of Soft Tissue Repair products inched down 1% to $226 million, as growth in the sutures and mesh products were masked by lower mechanical fixation sales.

Revenues from Oximetry and Monitoring sub-segment remained flat year over year at $210 million owing to higher sales of monitors and sensors. Vascular product sales jumped 14% to $418 million, backed by outstanding growth across peripheral vascular and neurovascular offerings. Moreover, Airway & Ventilation sub-segment sales edged up 1% to $184 million led by higher ventilator sales.

Revenues from Covidien’s Pharma segment remained flat year over year at $501 million. Robust gains in the Specialty Pharmaceuticals business were offset by lower Contrast Product sales.   

Specialty Pharmaceuticals sales surged 21% to $145 million spurred by solid revenue from Exalgo and Pennsaid products. Active Pharmaceutical Ingredients sales increased 3% as a result of higher narcotics sales but Contrast Product sales plunged 18% due to delay in customer order timing and sluggish U.S. markets. Revenues from Radiopharmaceuticals increased 1% on the back of healthy generator sales.

Sales from Medical Supplies segment were virtually flat year over year at $443 million in the third quarter as higher sales of Medical Surgical and Nursing Care products were offset by lower revenues from SharpSafety and Original Equipment Manufacturing (“OEM”) offerings. 


Gross margin improved to 57.8% in the third quarter from 57.1% in the year-ago comparable period. On an adjusted basis, gross margin increased to 58% from 57.1% in the prior year-quarter. The improvement was attributable to lower manufacturing costs and a favorable business mix. Adjusted operating margin stood at 22.5% compared with 22.1% a year ago.

The company plans to expand in emerging markets and hence it has increased its selling, general and administrative (SG&A) and research and development (R&D) spending. Selling, general and administrative expenses were higher at 31.1% of sales in the reported quarter compared with 30.3% of sales in the year-ago quarter.

SG&A expenses were partially offset by productivity gains. R&D expense increased to 5.3% of revenues versus 4.7% in the prior-year period.

Our View

Covidien is a leading global health care products company with a history of developing and manufacturing high-quality products in a cost-effective manner. The company boasts of a well-diversified product and technology portfolio. Covidien's larger Medical Device unit overlaps with the business of its competitors like Johnson & Johnson (JNJ), Becton Dickinson (BDX) and C.R. Bard (BCR).

Covidien is expanding its footprint in emerging markets, notably in Asia and Latin America, and boosting market share in core segments through investments in sales and marketing infrastructure. The company is on an acquisition spree and scooped up companies like BARRX, Newport Medical Instruments, superDimension, PolyTouch Medical in 2012 alone.

Recently, it completed its acquisition of Israel-based medical devices firm Oridion Systems Ltd. in late June 2012 to expand its foothold in emerging markets.

Mallinckrodt, the Pharmaceuticals business of Covidien teamed up with Horizon Pharma, Inc. (HZNP) to promote DUEXIS in the U.Sin the quarter.It also agreed to co-endorse a prescription medicine called the Sumavel DosePro for Zogenix Inc. (ZGNX) in the U.S. Management at Covidien believes that the co-promotion agreements represent a key opportunity for its pharmaceuticals business as Mallinckrodt prepares to spin-off next year, as announced in December 2011.

Moreover, Covidien continues to roll out new products and technologies, focusing on faster-growing products and markets and broadening its product range through acquisitions and strategic collaborations.In May, Covidienlaunched two products viz. the HALO90 ULTRA Ablation Catheter in the U.S. and Europe and the Endo GIA Radial Reload aided with Tri-Staple technology.

In June, the company introduced the Nellcor SpO2 in selected regions for treatment of respiratory ailments and also launched the world’s first knotless suturing device named V-Loc.

Covidien is also enhancing shareholder value through dividends and share repurchases, leveraging healthy free cash flows and strong earnings power. Moreover, the company is restructuring its three business units to boost cost structure. Cost savings from restructuring should help offset raw material price inflation and improve margins and profitability.

Covidien is well placed to achieve its long-term revenue and earnings growth targets based on its attractive fundamentals, effective execution, new product cycle, synergies of acquisitions and expansion into emerging markets. Moreover, its share buyback initiative is accretive to earnings.

However, sustained pricing/procedure volume pressure, fluctuating foreign exchange rates, a sluggish U.S. and European economy represents major headwinds. Our Neutral recommendation on the stock carries a short-term Zacks #4 Rank (Sell).

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