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Covidien plc (COV), Johnson & Johnson (JNJ): Five Reasons This Stock Can Surpass Its Sector

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Covidien plc (NYSE:COV)It’s been a tricky market for medical device companies in 2013, but you wouldn’t know it from Covidien plc (NYSE:COV)’s share price performance.

The stock is up nearly 23% this year, even while companies like Johnson & Johnson (NYSE:JNJ) have disclosed lower-than-expected growth in surgical procedures. Moreover, the spinoff of Covidien plc (NYSE:COV)’s pharmaceuticals business (to be called Mallinckrodt) turns it into a pure-play medical device company. Why is Covidien plc (NYSE:COV) outperforming its sector, and what can investors expect in future from the company?

Covidien plc (NYSE:COV) offers inexpensive, cost-effective solutions

Firstly, while the overall medical device market is bedeviled with weak spending patterns, Covidien plc (NYSE:COV)’s solutions tend to come at much lower ticket prices than many of its competitors. This means that a lot of its solutions fall under the radar of items earmarked for cutbacks.

However, other companies in the sector have not fared so well. For example, on its last conference call Johnson & Johnson (NYSE:JNJ) described the hospital capital spending market as being in a recession for the last 10 to 12 quarters. Indeed, Johnson & Johnson (NYSE:JNJ) only recorded 0.5% growth (excluding acquisitions) in its medical device & diagnostics division.

Meanwhile, Covidien plc (NYSE:COV) managed to grow constant currency revenues by 5% in the last quarter, despite coming up against some difficult comparables in its vascular product sales.

A breakout of its product revenue growth reveals pretty solid growth, and on its conference call, management affirmed its belief that growth would continue “to be slightly above market.”

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Source: Company SEC filings.

Second, many of Covidien’s solutions actually enable hospitals to reduce costs. For example, its energy devices division has some of the world’s leading minimally invasive surgical (MIS) equipment.

Covidien’s MIS solutions allow hospitals to create better patient outcomes, and save costs by reducing outpatient days. Such properties mean that hospitals keen on restraining spending will still consider making purchases. Moreover, in previous conference calls, Covidien argued that it could generate growth by increasing MIS use in procedures such as hysterectomies and colorectal surgery.

Emerging markets, obesity, and cost savings

Third, emerging markets present a strong growth opportunity. According to company presentations, Covidien plans to reach $2 billion in emerging market sales within the next couple of years. The current percentage of overall sales from emerging markets is around 15%, and a move to $2 billion would probably take it nearer to 20%. This looks achievable, because in this quarter alone, Covidien recorded “operational sales growth in the mid-teens and double-digit increases in most product lines” within emerging markets.

This compares favorably with what General Electric Company (NYSE:GE) reported in its health-care division recently. General Electric Company (NYSE:GE) outlined that its emerging-market growth was up 10%, while developed-market revenues declined 4%. In the end, General Electric Company (NYSE:GE)’s health-care revenues were flat on the last quarter.

The first two reasons discussed above are a big part of Covidien’s appeal to hospitals in emerging markets. Its products are not the kind of high-ticket capital machinery solutions that will make poorer countries balk at up-front purchases. In addition, areas like endomechanical and energy devices (MIS) enjoy significant growth potential because they haven’t yet expanded much into those emerging markets.

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