JMP: St. Jude, Medtronic best bets in medical device stocks; still wary of orthopedics

By E. Janene Geiss

Philadelphia, Jan. 6 - JMP Securities said its 2006 outlook for medical devices companies is much rosier than it was this time last year with the cardiology sector as an area of opportunity.

But research analyst Robert C. Faulkner said in the Jan. 6 report that he is still wary of orthopedics.

"Last year at this time we were in a morose state with a group of expensive stocks with decelerating top and bottom lines," Faulkner said in the report.

"This year, some of these stocks actually look good," Faulkner said. "We have conviction that we can see 15% to 20% return, maybe better, in St. Jude Medical Inc. and Medtronic Inc., and maybe a shot at 60% in Boston Scientific Corp. over two years if the Guidant purchase happens and succeeds as we believe it should."

Those three stocks appear better than any of these big stocks looked last year, he said.

As far as orthopedics, Faulkner said, some stocks actually look better, but only because there is less downside.

Faulkner said he sees no reason to own orthopedics right now. Overall, he said, these are stocks to own eight out of 10 years. The two years not to own them have nearly passed, but not entirely, he said.

JMP recommends owning the following stocks in the following order for 2006:

• St. Jude Medical Inc. is rated a strong buy due to earnings per share potential near-term and strong management for long-term stewardship. The downside is it is a favorite, Faulkner said, but the stock price says it can keep marching with growth.

• Medtronic Inc. is rated a strong buy and viewed as underappreciated. Having stepped sideways for years, the company is on a sustainable upward trajectory. Faulkner commented: "Where else can you find 15% earnings per share growth, nearly 1% yield and enough cash flow to buy other big companies?"

• Boston Scientific Corp. is rated market outperform and seen as having the most upside in the group, but with the least visibility because it is contingent on a proposed deal with Guidant. If it wins the deal, it will become JMP's favorite stock, Faulkner said.

• NxStage Medical, Inc. is rated market outperform and has a great story long-term because the demand drivers appear to be so powerful, Faulkner said.

The remaining stocks are effectively not recommended as longs, Faulkner said.

• Johnson & Johnson is rated market perform and has a new low valuation, but Faulkner said it reflects renewed and legitimate concern about the pharma business and apparent obsolescence of Cypher at the hands of the Guidant stent. This stock may face higher risk to earnings per share growth than the rest in the group.

• Guidant Corp. is rated market perform. Boston Scientific is the preferred stock on the possibility of the merger as it offers less downside if the deal doesn't happen. The stock could fall below $63 if Boston Scientific doesn't make a bid and has an upside to just less than $72 if the Boston Scientific deal happens, Faulkner said.

• Stryker Corp. is rated market perform as it relates to the orthopedic market. The company may be able to meet 20% growth in the near term and valuation reflects much lower growth, Faulkner said. Concerns include the ability to meet that growth in the face of slow orthopedic sales.

• Zimmer Holdings Inc. is rated market underperform as a pure-play on deceleration in the orthopedic market. Faulkner said it is exposed to a negative cycle.

• Biomet Inc. is rated market underperform due to the slow orthopedic market, but faces the additional challenges in businesses with technological obsolescence underway, electrical stimulation to Medtronic's Infuse and the trauma business to new plating technology that the company should be able to imitate eventually, Faulkner said.

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