Last month we looked back at a big winner, eBay. Let’s flip things around this month and look at an underperformer from last October’s IAS.
The market was doing poorly when our October 2011 issue went to press. Confusion in Europe and appeared to be weighing heavily on the U.S. stock market. We encouraged readers to look past negative headlines toward data showing modest, but sustained, economic growth here in America. Retail sales and manufacturing were both showing improvement. The labor market remained weak but seemed not to be worsening. As it turned out, the S&P would bottom at 1075 on October 4th, then rally to over 1,400 in early 2012.
One of the three companies we profiled in the October 2011 issue was St. Jude Medical (Ticker: STJ). Trading at $44.96 a year ago, the stock recently traded at $39.50, a loss of 10% after adding back interim dividends. The medical devices industry has underperformed over the last year. The iShares Medical Devices ETF (ticker IHI) lags the S&P 500 by about 7%. However, St. Jude’s problems appear to run somewhat deeper than the average industry participant’s.
A manufacturer of pacemakers, defibrillators, and other heart-health products, as well as groundbreaking pain management devices, St Jude enjoyed a decade of steady, double-digit growth in sales and earnings. Recent results had been below-trend, but we expected some reacceleration on the back of new product launches.
Results have underperformed our expectations. The first fiscal quarter following our write-up seemed to be in line with our investment thesis on the stock. St Jude outgrew its market and showed a nominal double-digit sales increase. A weakening U.S. dollar was responsible for about half of that growth, however. Too, EPS growth lagged sales but still increased a respectable 8%. As the broader averages recovered going into 2012, STJ shares remained depressed.
As often happens in the market, STJ’s share price weakness anticipated deteriorating results. In fact, by the time the really bad news actually broke, the stock had already bottomed and started to recover. Fiscal Q4 2011 showed more slowing on the sales line, along with a sharply-reduced 2012 forecast. The company still managed double-digit earnings growth, but it came through aggressive restructuring efforts. Cost-cuts tend to be hard to sustain. We considered the company’s expectations of mid-single sales growth subpar, but we saw upside as well given that the firm has typically given conservative guidance in the past.
Not this time, however. First quarter sales grew only 1%. By the company’s estimates, the total Cardiac Rhythm Management marketplace declined 4%. When a rising tide starts to recede, industries begin to change. Price competition becomes more cutthroat. St. Jude also became the subject of negative press alleging that some of its implantable products were prone to electrical shorting. Frustratingly for investors, it took the company too long to mount a credible response. This created a cloud of uncertainty—never a positive in the stock market. Meanwhile, the company’s normally-steady stream of new products hit a lull, so much so that Q2 sales actually showed a year-over-year decline—so much for conservative guidance. Shares have once again recovered somewhat since those disappointing results came in. In the presence of a generally strong market, investors appear optimistic that St. Jude will finally start to feel the updraft we were predicting a year ago. Maybe our bullish call on St. Jude will just turn out to be early, rather than flat-out wrong. Readers know and expect that we try to get our timing closer than that. Sometimes you swing and miss.
Disclaimer: This company was selected for review in part because of its performance over the past year. Any outperformance relative to the broader market is not necessarily indicative of performance of the broader Investor Advisory Service.