St. Jude Medical (STJ; $33) is one of the largest manufacturers of medical devices, with nearly $4 billion in 2007 sales and significant share of device product categories, including cardiac rhythm management (CRM), heart valves, and neuromodulation (see below) devices. However, while St. Jude has a diversified revenue base, its primary market, accounting for 63% of 2007 revenues, remains cardiac rhythm management, where it sells both defibrillators and pacemakers and where the company competes primarily against Boston Scientific (BSX) and Medtronic (MDT).
Although we believe CRM will remain the principal area of focus for investors, the company has been generating very strong growth in both the neuromodulation and atrial fibrillation categories. And while we think the revenue streams from these categories will remain somewhat volatile as those markets continue to develop, we think they both represent significant new growth drivers for St. Jude—critical elements of the company's five-year minimum objective of generating sales and earnings growth of 15%.
In our view, St. Jude shares are very attractively valued, recently trading at 14.1 times our 2008 EPS estimate of $2.30 and 12.3 times our 2009 estimate of $2.65. Although both valuation metrics represent premiums to the Standard & Poor's 500-stock index, the stock's p-e is modestly discounted to the large-cap medical device group average of 15.9 times 2008 EPS and 13.6 times 2009 EPS. At 2.6 times estimated 2008 sales, the stock is priced in line with peers and, based on our $790 million free cash flow forecast for 2008, offers a free cash flow yield of 5.9%, vs. 3.4% for peers. Our 12-month target price of $54 assumes the stock will command a price-to-earnings growth (PEG) ratio of 1.4 times, in line with peers, assuming 15% three year EPS growth and applied to our 2009 EPS estimate of $2.65.
St. Jude, which is expected to report third-quarter results on Oct. 15, carries Standard & Poor's highest investment recommendation of 5 STARS (strong buy).
Company Profile
Minnesota-based St. Jude Medical is one of the leading manufacturers and sellers of medical devices, with more than $4.0 billion in sales expected for 2008 and significant share of the global cardiac rhythm management market, whose size we estimate at about $10 billion in 2007 with a projected annual compound annual growth (CAGR) rate of about 8% during the four-year period from 2007 through 2012. CRM represented 62.7% of total sales in 2007. The company also sells products in the cardiovascular (20.9%), atrial fibrillation (10.9%), and neuromodulation (5.5%) market segments.
Cardiac Rhythm Management
Within the CRM business, St. Jude sells products for the treatment of irregular heartbeats. The two main product lines within CRM are implantable cardioverter defibrillators (ICDs) for the treatment of patients whose hearts beat too rapidly, and pacemakers for those with hearts beating too slowly. During the period from 2002 to 2004, the ICD market expanded by an average of 34% annually, we believe as a direct result of some favorable clinical data showing improved mortality vs. standard drug therapy due to the implantation of an ICD in patients seen at risk of sudden cardiac death. We think this development helped open the ICD market to a new pool of candidates, which led to sharply higher procedure rates globally.