Marcial: Vital Signs at St. Jude Medical

The maker of cardiac rhythm management products is anticipating rising demand overseas, and at home has a robust balance sheet and cash flow

For certain types of health care, spending isn't discretionary: When you are having, say, a heart problem, you don't postpone treatment or medical help. So you would think that makers of life-saving medical devices would be classic defensive (i.e., recession-resistant) plays. Yet the stock market has been, well, heartless, as health-care stocks have been battered with the rest of the market.

But that's all the more reason why some stocks in the sector have become compelling buys. After all, many of the companies that have been smacked around have solid fundamentals, and the price declines have made them more attractive.

One example: St. Jude Medical (STJ), a leading maker of cardiac rhythm management devices, including implantable cardioverter defibrillators (ICDs). These devices are used to treat hearts that beat too fast by monitoring the heartbeat and delivering high-energy electric impulses to stop the erratic beating. St. Jude also makes pacemakers and other cardiac devices.

Shares of St. Jude, like most other stocks, have been walloped: It's down to 30 a share on Dec. 9, from a 52-week high of 48.49 on July 17. In 2006, the stock traded as high 54.80. Its current price-earnings ratio of 13.6 compares with its five-year high of 51 in 2005.

Health Profit Outlook

But the decline hasn't turned off the bulls. "We continue to view St. Jude as attractively positioned to deliver sustained and above-average market sales and earnings growth," says analyst Michael Jungling of Merrill Lynch (MER), who rates the stock a buy, in a Dec. 2 report.

Because of the effects of the stronger U.S. dollar on overseas sales, St. Jude has lowered its forecasts for the fourth quarter, prompting analysts to cut their own estimates as well. Nonetheless, Wall Street remains generally bullish on the stock, with 18 analysts recommending it as a buy and 9 rating it a hold, according to data from Bloomberg. Only one analyst tags it a sell.

St. Jude's shares have been vulnerable to massive selling of stocks in the broader market driven by hedge funds and mutual funds as they unload sizable holdings in order to meet their financial obligations to clients or investors demanding to get their money back. That selling is not triggered by fundamental flaws in companies' operations.

St. Jude is certainly in a strong financial position. "We are optimistic about the company's ability to continue posting healthy profit gains," says analyst Erik A. Antonson of independent investment research company Value Line (VALU). He has upped his 2008 per-share earnings estimate by 15¢, to $2.33, on sales of $4.4 billion. He lifted his 2009 EPS forecast by 10¢, to $2.60, on $4.8 billion in sales.

Takeover Candidate?

Analysts expect St. Jude to continue capturing market share in the global market for ICDs. "We think the cardiac rhythm management products, which accounted for 63% of sales in 2007, will grow by about 5% to 7% in the coming three years as a maturing market in the U.S. is outweighed by rising demand overseas," says analyst Robert Gold of Standard & Poor's. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP.) He rates the stock a hold, with a 12-month price target of 32 a share.

Gold notes that from 2002 to 2007, St. Jude generated a compounded annual growth rate in sales of 18.9%, and a growth rate of 19.5% in operating earnings per share, well above those of its large-cap medical device peers. And despite the current economic recession, Gold says St. Jude can generate average annual sales growth of 12% and earnings growth of 13% from 2008 through 2010.

There's another reason why Gold is bullish on St. Jude: He believes the company is an attractive takeover candidate because of its focus on cardiac rhythm management, strong cash flow generation, and its "conservatively managed balance sheet."

He didn't mention any possible suitors, but it's worth noting that St. Jude's big rivals are Medtronic (MDT) and Boston Scientific (BSX). But with or without the takeover factor, St. Jude is an attractive buy. Jason Mills of Cannacord Capital says, "We favor nondiscretionary med-techs like St. Jude; it has a strong balance sheet and cash flow generation, and it has an attractive valuation, selling at a discount to its bigger rivals in the business."

A market-leading med-tech with strong fundamentals and an attractive valuation? It's enough to make your heart skip a beat.

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