Markets & Finance

A Quickening Pace


By Robert Gold Minnesota-based St. Jude Medical (STJ) designs, manufactures and markets medical devices, with a primary concentration on products for use in the heart. Historically, St. Jude was focused on solely on the sale of heart valves, but in recent years it has emerged as one of the leading participants in areas such as cardiac rhythm management, electrophysiology (EP) catheters and various cardiac surgery products. S&P recently upgraded the stock to its highest investment opinion, 5 STARS (buy), and we are presenting it as our Focus Stock of the Week.

The company's principal product category is cardiac pacemakers, which should provide roughly half of its sales in both 2001 and 2002. Sold under the Integrity, Affinity, Entity, Trilogy, Tempo, AddVent, Recency and Microny trade names, these products all offer the unique feature of the beat-by-beat Auto Capture pacing system. Auto Capture enables the pacemaker to monitor each paced heart beat to verify that the heart has been stimulated (captured), deliver a backup pulse in the event of that stimulation has not occurred, continuously measure threshold and make adjustments in energy output to match changing patient needs.

KEEPING PACE. Standard & Poor's estimates that the worldwide pacemaker market in 2001 will total $3.0 billion, representing an approximate 5% growth rate over 2000. Based on that estimate, we at S&P believe St. Jude will conclude 2001 with an approximate 24% market share, ranking second only to Medtronic's estimated 50% share. But its projected 2001 growth rate of 8.5% should lead the industry. Some of this market share expansion will likely reflect strong physician acceptance of the new Afx algorithm for the suppression of atrial fibrillation (irregular heartbeat). St. Jude sees 10% to 15% pacemaker growth in the fourth quarter of 2001, and we are conservatively looking for 8% growth in 2002.

The company also makes implantable cardioverter defibrillators (ICDs), which are used to restore normal heart rhythms in patients whose hearts are beating too fast, a condition known as tachycardia. Though ranking far below pacemakers in terms of revenue contributions -- projected sales contributions are for 15% in 2001 and 17% in 2002 -- the ICD business is viewed as a key growth driver for St. Jude. S&P estimates that the worldwide ICD market will total $1.9 billion in 2001, with a growth rate of 12% over 2000. By comparison, we are projecting that St. Jude will generate ICD sales growth of 15% in 2001, aided by its successful launch of the Photon dual-chamber ICD, and will end 2001 with an approximate 11% share of the global market, ranking third behind Medtronic (51%) and Guidant (36%).

We believe the company's sales mix will continue to shift towards defibrillators in 2002, with segment revenues conservatively forecast to grow by 18%-19%. However, our expectations for 2002 and beyond could prove extremely conservative based on recently released clinical trial data that supports the use of ICDs rather than conventional drugs in treating heart attack survivor patients.

BRIGHT PROSPECTS. According to the data flowing from a trial sponsored by Guidant Corp., ICDs were shown to lower mortality levels by up to 30% versus drug therapy. If ICDs are approved by the FDA for this indication, we believe the target patient population for these devices could double, to 600,000 annually, by 2004. We believe each 5% growth in industry wide ICD unit sales translates to about $0.07 in annual EPS for St. Jude based on current market share estimates.

The outlook for the company's heart valve business isn't quite as rosy. Prospects continue to be hurt by the steady conversion in the medical community towards tissue, rather than mechanical, valves. We believe the worldwide heart valve market will grow by only 1% in 2001, and look for St. Jude's valve revenues to decline 4% in 2001. No growth is expected in 2002. We believe this division will represent 18% of 2001 sales, declining to 15% of sales in 2002.

Other significant product categories include cardiology vascular access (CVA), which revolves around the AngioSeal vascular closer device, and the DAIG/Electrophysiology unit that produces specialized disposable cardiovascular devices. On a combined basis, these businesses should represent 16% of 2001 sales and 19% of 2002 sales.

UPSIDE POTENTIAL. We at S&P see the company posting earnings per share of $2.25 in 2001, up 24% from 2000, on sales growth of 14%. Looking into 2002, we see EPS (before an expected $0.20 benefit from goodwill accounting changes) rising at least 16% to $2.60, based on a conservative sales growth forecast of 14%-16%.

The stock is valued on par with its peers in the medical device industry at 28 times our 2002 EPS estimate. But on a price-to-sales basis, it trades at a 15% discount to its peers -- at only 4.3 times estimated 2002 sales. We feel St. Jude should command a premium valuation given its favorable growth trajectory, recent history of upside revenue and EPS surprises, and possible takeover appeal to one of the larger medical device participants lacking sufficient cardiology exposure. As so we have a 12-month target price of $91 on the stock, or 35 times our 2002 EPS forecast, representing a potential 23% appreciation from recent levels. Gold is an equity analyst for Standard & Poor's


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