I recently performed a sector analysis for my dividend growth stock portfolio and noted that I was underweight in the healthcare sector. Therefore, today, I wanted to perform a stock analysis over a Dividend Aristocrat in the sector: Medtronic plc (NYSE:MDT). Today’s analysis will review the company, their recent performance, and run the company through the Dividend Diplomats’ Dividend Stock Screener to determine if the company is an undervalued dividend growth stock. The company does not appear to be undervalued at the moment; however, let’s dive in to the details and see.
Medtronics released the third quarter results on February 19, 2019. There was a lot of great information in the earnings release. We will review the income statement, discuss the updated FY 19 guidance provided by the company, and then review the company’s balance sheet.
First, in terms of the income statement, the results were pretty positive. The company realized revenue growth of 2.4% and 4.4% organic revenue growth. MDT also saw an increase in the company’s operating margin by 90 basis points and a strong increase in operating/free cash flow compared to the same nine-month period last year. Not only is the company growing and increasing earnings, but there is more cash coming in the door.
The company reports four major operating segments in their financial statements: Cardiac & Vascular Group, Minimally Invasive Therapies Group, Restorative Therapies Group, and Diabetes Group. All of the operating segments saw an increase in revenue during the 9 month FY (when adjusted for divestitures that occurred in FY 2018). To me, this is an excellent sign. One specific unit is not carrying the company or masking the revenue growth problems of the other sectors. Each contributed to the adjusted growth in some capacity.
I also mentioned the company updated their revenue guidance. This was great news to see for the company. To start, the company increased the floor of their organic revenue growth range. Prior to the release, management had a range of 5.0% – 5.5% organic growth for the year. Now, management’s guidance is a range of 5.25% – 5.5%. It was a similar story for the company’s free cash flow range, which saw the floor of the range increase much more dramatically than the ceiling. The company’s FCF is now expected to be between $5.0b – $5.2b (b = Billions), compared to the previous estimate of $4.7b – $5.1b. Lastly, the EPS range remained the approximately the same. Before, management had a target EPS range of $5.10/share – $5.15/share. Now, the guidance is a tighter range of $5.14/share – $5.16/share.
As a dividend investor, I love this quarter’s earnings release for a few reasons. The company performed very well and demonstrated strong revenue growth across all sectors. Similarly, the company’s cash flow from operations and earnings were strong as well. To add to this, the guidance updates I summarized in the previous paragraph were great news as a dividend investors. Not only did the results confirm the strong performance, but it indicated the company will have more capital than expected at the beginning of year. Could this mean a larger dividend increase for shareholders? Potentially, especially if the company hits at the top end of their guidance. But it could also mean that the company has extra cash for larger share repurchases or debt paydowns. Once again, great options to provide value to shareholders and improve the company’s financial position.
To review the balance sheet, I wanted to take a look at the company’s current ratio. Typically, we like to see a current ratio greater than 1X. This indicates that the company can cover the liabilities due over the next 12 months with their current assets. For this, MDT knocks it out of the park. As of 1/25/19, the company’s current ratio is 2.35X ($20,877M/$8,853M; M = Millions). This was very much in line with the 2.28X posted at the end of the company’s previous fiscal year, 4/27/18 ($22,980M/$10,084M). This is exactly what I wanted to see for this analysis.
Dividend Diplomats Stock Screener
The metrics looked great from the earnings release and 10-Q. Now, it is time to put the company through the Dividend Diplomats’ Dividend Stock Screener. This is our simple stock screener that we use to determine if the company we are analyzing currently passes our investment filters used to identify undervalued dividend growth stocks. If a company passes our screener and a few other metrics, we will consider purchasing. Our stock screener uses three simple screens to identify the stocks: P/E ratio (valuation), dividend payout ratio (ability to continue growing their dividend), and their dividend growth rate/history of increasing their dividend (as we focus on companies that have demonstrated their ability to increase their dividend over a long period of time). Let’s see the results!
| Ticker | Price – 3/7/19 | Forward EPS | Annual Dividend | Yield | Payout Ratio | 5-Yr DGR | P/E Ratio |
| MDT | $91.08 | $5.15 | $2.00 | 2.20% | 38.83% | 8.29% | 17.69 |
**Sources: Pricing information, forward EPS, and annual dividend were obtained from Yahoo! Finance. The 5-year average dividend growth rate was obtained from Dividend Investing|Best Dividend Paying Stocks. The remaining figures in the table above were calculated by the author.
1) Dividend Yield: Typically, I look to invest in companies with dividend yields exceeding the S&P 500 yield of just under 2%. Otherwise, I would consider investing in a nice, diversified S&P 500 mutual fund, or ETF. MDT’s dividend yield is slightly above the market’s dividend yield, but not by much.
2) Payout Ratio: We typically use a 60% threshold when reviewing a company’s payout ratio, as we believe this percentage point allows a company to continue to grow their dividend going forward without sacrificing the safety of their dividend. MDT’s dividend payout ratio is well below the 60% threshold we use. On top of it, the company’s payout ratio of only 38% indicates that there is plenty of room to grow their dividend going forward.
3) Dividend History and Dividend Growth Rate: I’ve already mentioned that MDT is a Dividend Aristocrat and has increased their dividend for 41 consecutive years. I don’t see any reason why the company won’t continue this streak in June, the month that MDT typically increases their dividend. On top of it, the company has a 5-year average dividend growth rate of 8.29%. This is a very solid dividend growth rate. The last two dividend increases were 8.7% and 6.98%; so the company has been pretty consistent with their increases over the last few years.
4) P/E Ratio: The final metric of our stock screener focuses on the current valuation of the company. I’m always looking for companies that are trading at a multiple below the broader market. Currently, the broader market has a historical P/E ratio in the mid-20x and a forward P/E ratio between 17x and 18x (per The Wall Street Journal). Right now, MDT’s P/E ratio is 17.69X. They are right in line with the broader marketplace. Not undervalued, not overvalued. Right in line!
Summary
What does this tell us? Medtronics is a great company in a sector that needs addressing in my dividend growth stock portfolio. The company posted great results, has a strong balance sheet, and a strong dividend growth history. The company is not trading at a discount to the marketplace, as indicated by the P/E ratio review. However, that appears warranted based on the company’s strong performance. With that being said, since I am always looking for an undervalued dividend growth stock, I am going to pass on adding Medtronic today. The company has earned a strong place on my dividend stock watch list though. If there is a pullback in the company’s price, which would then cause the company to trade at a discount, I will strongly consider adding. If the company’s dividend yield eclipses 2.5% ($80/share), I will strongly consider adding them to my portfolio!
Do you own Medtronics? Are you looking to purchase shares in the company at the current levels? Or, like me, are you waiting for the price to fall to a lower level? If so, what level are you looking to purchase at? What are your thoughts about their recent earnings release? Do you have anything else you would like to add in the comment section?
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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