Covidien Is Growing Where Others Don't

NEW YORK (TheStreet) -- Shares of Covidien (COV) are up 14% so far on the year, while posting gains of almost 25% over the past six months. When going back a little further to its low of $44.52 in January 2012, this stock is up almost 50%.

Remarkably, no one's talking about it.

Even though I've always had a great deal of respect for the larger medical technology rivals including Johnson & Johnson ( JNJ) and Abbott Laboratories ( ABT), I've admired Covidien's growth and solid execution.

Regrettably, I've never had guts to buy the stock.

Now that Covidien has taken off, I wonder how long management can sustain this level of performance while avoiding the inevitable trip-ups commonplace in this sector.

After a solid first-quarter performance where Covidien beat on both the top and bottom lines, the company had even more dominant second-quarter results. For investors waiting to buy on a possible pullback, this isn't the quarter where that's likely to happen.

In this sector, quarterly performance is measured by how well companies can grow organically, despite what the operational results may show. To that end, Covidien's 5% organic growth performance stands as one of the best among the med-tech companies that have reported thus far, including Johnson & Johnson and Abbott Labs.

By contrast, even though Johnson & Johnson just posted almost 9% revenue growth and is a dominant player in the med-tech space, concerns about the company's organic growth have emerged as a result of just 3% growth this recent quarter. JNJ is eight times the size of Covidien.

Here too, Covidien's "nimbleness" introduces another attractive quality: JNJ is seen as being too big.

When comparing Covidien to Abbott Labs, which is only twice the size of Covidien in terms of market cap, the story looks even better because Abbott posted only 2% revenue growth this quarter. Similarly, in the devices business -- which has seen a broad decline within the sector -- Covidien's 6% growth really stands out, albeit on an operational basis. By contrast, Abbott posted a 3% decline.

What's more, increases were seen in almost every businesses division. Covidien's drug segment was equally impressive, growing at 13% year over year, outpacing Johnson & Johnson by 2%. Likewise, Covidien's API (active pharmaceutical ingredients) business was up 12% and the company posted a stout 53% increase in Specialty Pharmaceutical sales.

Management said the strong pharmaceutical performance was partly due to the company's new product launches in the first quarter, which included HCI ER tablets as well as a strong performance from such drugs as Exalgo. It wasn't all good news, though, as the Contrast Products business and Radiopharmaceuticals edged down 11% and 6%, respectively.

It's hard to not have been impressed by this performance. But solid growth and execution has been the standard here for well over a year. Now that Covidien is no longer a surprise, it's worth speculating on how long this performance can continue. Ordinarily, there would be signs of slowing down but I see nothing but possible upside from here.

That's not to suggest, however, that this company is flawless. The weakness in the Contrast Products business and in Radiopharmaceuticals serve as opportunities for improvement. Investors shouldn't underestimate what a resurgent Johnson & Johnson and/or Abbott Labs can do to thwart Covidien's progress.

While organic growth remains an issue in their respective businesses, particularly in devices, neither JNJ or ABT will just cede any portion of the market to Covidien.

The question, then, is to what length Covidien will go to maintain its growth trajectory, while also maintaining it margins - given its deficit in size when compared to Abbott and Johnson & Johnson.

In that regard, there are also questions about how much value will be unlocked if and when Covidien does spin off its drug business, Mallinckrodt, later this year. This is something Abbott knows about all too well after spinning off its drug business AbbVie ( ABBV) in January. As noted above, this is a move that Johnson & Johnson has resisted, despite investors' pleas.

Bottom Line

Covidien's management has targeted mid-2013 for the spinoff, which suggests any time after the end of this month (May). It remains to be seen how this move will impact upon Covidien's remaining business, which will then place a new focus on (among others) the devices segment, which has not been as impressive as the pharmaceuticals.

But the good news is the "leaner" Covidien should add a boost to margins, which just missed Street estimates. In the meantime, Covidien investors have plenty of reasons to be excited about the growth trajectory of this company.

The stock, however, is no longer cheap. But given the momentum in the drug business and optimism that surrounds the spinoff, it's hard to bet against more gains.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Saintvilus is a private investor with an information technology and engineering background and the founder and producer of the investor Web site Saint's Sense. He has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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