Medtronic plc (NYSE: MDT), a leading medical developer and manufacturer of medical devices in the Diabetes, Cardiovascular, Neuroscience, and Medical Surgery spaces, is in the midst of a transformation aimed at improving its operations and financial performance. Over the last seven years, the company has significantly underperformed in the market, as can be seen in the chart below, in the growth of fundamentals and total return for shareholders.
Despite facing challenges in recent years, the company is implementing a turnaround strategy to regain its competitiveness and increase shareholder value. This article will take a closer look at the elements of Medtronic's turnaround plan
A turnaround in four steps
Medtronic's turnaround story has four areas of focus:
- Capital Allocation
- Operating model
- Culture
- Management Incentive
Let's take a look at the different steps.
A better Capital Allocation
Medtronic shared its steps to improve capital allocation. The company wants to focus on R&D and "smart" M&A to drive growth and on Dividends to return capital to shareholders. The company has been steadily increasing its R&D investments from $2 billion to $2.7 billion since 2016. R&D should allow the company to generate organic growth.
I wouldn't say I like that the company talks about "smart" M&A, I am not a fan of companies giving names like that to their strategy without elaborating on it. Everything they say is that they focus on tuck-in/bolt-on acquisitions with a heightened focus on a market selection. But what about the criteria that make it smart? What is the IRR hurdle? How does the company make sure deals are accretive? Will M&A be paid in cash, debt, or equity? Does ROIC play a role in the process? Especially the last point is very important if we consider that MDT has a negative ROIC-WACC spread, according to Gurufocus. If the ROIC-WACC spread is negative, then the company destroys value (less return than the cost of capital), so ROIC should be a priority.
Additionally, the company is looking to streamline its portfolio. It is spinning off its Patient Monitoring and Respiratory Interventions business into "NewCo", undoubtedly the most thoughtful name I heard in quite a while. This represents around 7% of revenues and won't have a very material impact, but it shows that management wants to streamline the company.
, exploring the changes the company hopes to make and the impact it will have on its future. The last part of the Capital Allocation is the return on capital. Medtronic has a long history of growing dividends at 45 years of raises, making them a Dividend Aristocrat and almost a dividend king (50 years of raises). Additionally, the company repurchased a lot of shares in the past. Let's take a look and see if that was a good use of capital. Over the last seven years shares outstanding increased significantly. I look at seven years instead of my usual ten, because a large acquisition increased the share count by around 40% in 2015.