We reiterate our Neutral recommendation on Medtronic (MDT) with a target price of $40.00.

The company’s revenues and earnings during the fourth quarter of fiscal 2012 surpassed the Zacks Consensus Estimates. Trends in the previous fiscal have been divergent for Medtronic. While 75% of the business grew at 8%, almost 25% declined 10%. However, management confirmed that both the ICDs and spine markets are gradually stabilizing, which will result in easier comparisons and should drive growth over the coming quarters. The improvement was more pronounced in the fourth quarter as 90% of the business grew at 7%.

Despite sustained weakness in its key ICD and spinal implants businesses, we like the company’s efforts to augment/diversify its product range, expand into emerging markets for growth, and target to return 50% of free cash flow to shareholders through dividends and buybacks. We are optimistic that over the long term, stability in the US ICD market along with a deep pipeline/portfolio that includes – CoreValve, Resolute Integrity, Atrial Fibrillation, renal denervation and peripheral businesses – will be the driving factors for the company going ahead.

Medtronic continues to benefit from the recently launched products. The company gained share in both the domestic and international markets banking on Revo MRI SureScan pacemaker. Besides, the atrial fibrillation business recorded over 20% growth despite one-year completion of the US launch of Arctic Front cryoballoon. The launch of RestoreSensor spinal cord stimulator in the US (leading to 6 points of share gain on a sequential basis) and Japan contributed to the growth of the neuromodulation business. The company witnessed market share gain subsequent to the recent launch of Resolute Integrity drug eluting stent for the treatment of coronary artery disease, even in patients with diabetes mellitus.

Medtronic has decided to focus on globalization due to the opportunity rife in international destinations, especially in the emerging markets. Management is targeting 20% (from the current level of 11%) of its revenues from the emerging markets by fiscal 2015-16 that will result in additional 300-500 basis points of revenue growth.

However, we remain concerned about the challenges of the ICD and spinal segments. Sales of core metal construct products declined 3% year over year (but grew 5% sequentially) during the reported quarter. Infuse sales dropped 26% year over year in the quarter including a 24% drop in the US market, in line with the third quarter. This decline will continue till results from the Yale study are available, due in the second quarter of the current fiscal. The competitive landscape is quite tough with the presence of players such as Boston Scientific (BSX) and St Jude Medical (STJ).

Our recommendation is backed by a Zacks #3 Rank (Hold) in the short term.

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