Medtronic defends merger progress despite slipping profit margin

The integration of Covidien and Medtronic into a single healthcare-products company is going well, company executives argued Tuesday, fending off market skepticism about the combined company's operating performance.

Amid rising stock prices Tuesday, Medtronic shares dipped 4 percent to close at $74.18 after the company released earnings. Investor scrutiny focused on whether the company should be turning in better operating margins since buying Covidien in January 2015.

Raj Denhoy of Jefferies said during the company's earnings call that many investors are using the operating margin to evaluate the $49.9 billion Covidien transaction, and JPMorgan Chase analyst Mike Weinstein said the operating margin expansion "wasn't what I think people were hoping."

The medical device maker reported an adjusted operating profit margin of 27.8 percent on revenue of $6.93 billion in the three months ended Jan. 29. A year ago, that margin was 30.2 percent; management had been expecting at least 28 percent in the most recent quarter.

"This operating team is delivering," Chief Executive Omar Ishrak told the analysts. "But you know, there's only so far you can go about things that are not in our control. I do want to make the point that we haven't lost our operational focus on delivering these synergies one bit, and in many ways, are a little bit ahead of our original commitments. But there are a lot of moving parts."

Medtronic executives have predicted synergies of $850 million within three years by cutting expenses like redundant office space and back-office personnel and optimizing distribution systems and supply chains. On Tuesday, Chief Financial Officer Gary Ellis said Medtronic was ahead of the goal of $350 million in such savings during the fiscal year that ends in April.

The chief culprit for Medtronic missing its operating margin expectations in the most recent quarter, executives said, was sales in foreign currencies that declined against the dollar during the quarter. Executives singled out the Argentine peso in particular, which sank unexpectedly in December and cost Medtronic $21 million.

"We are right in line with things," Ellis said, but the negative impact of foreign currencies is "kind of camouflaging some of the real benefits we are seeing from an operations perspective."

Ben Marks, president of Minnetonka-based Marks Group Wealth Management, said Tuesday's sell-off in Medtronic stock probably reflected the fact that the company didn't "blow it out of the park" with earnings after shares have handily outperformed the S&P 500 since the start of the year.

Marks Group decreased its Medtronic shares last year after the Covidien transaction, partly out of concern about whether the deal could live up to expectations. But a year after the deal, the deal appears to be going well, he said.

"The merger went better than I would have expected," Marks said. "I was a little nervous about it, which is why we trimmed our position a little bit. But I think that, a year into it, if there were some skeletons in the closet, so to speak, I think they would have appeared by now. So I think that is largely behind us."

Medtronic reported adjusted earnings of $1.06 per share Tuesday morning, meeting Wall Street expectations but dipping by 1 percent compared with the same quarter last year.

Its $6.93 billion in revenue for the quarter, was 6 percent better than the same period last year but below the average analysts estimate of $6.99 billion.

Operating income before taxes fell by 1 percent, to $1.18 billion, during the quarter. (Net income actually rose 12 percent compared to the prior period, after accounting for a $133 million drop in net income tax expenses from a year ago.)

Each of Medtronic's four major sales groups posted sales increases, including 7 percent currency-adjusted growth in its largest unit, cardiac and vascular devices, which had $2.41 billion in revenue. The minimally invasive therapies group, largely comprised of lower-margin Covidien devices, grew by an adjusted 5 percent to $2.29 billion.

On Tuesday, Medtronic said its full-year diluted adjusted earnings per share will fall in a range of $4.36 to $4.40 during its fourth-quarter earnings announcement, which will be in May.

Joe Carlson • 612-673-4779