Medtronic: Diabetes Growth Key to Hitting Longer-Term Targets

Management Expects 4%+ Organic Growth Longer-Term

On June 6, 2018, management held an Investor Day to outline its new long-term targets to investors. The key financial targets of that plan were 4%+ organic growth, 40-50 bps of margin expansion, and 8% adjusted EPS growth.

Investors were focused on the drivers in getting to management's 4%+ organic revenue growth target. Management detailed the drivers of their 4%+ target: they expect growth in line with the corporate average across its Cardiac & Vascular Group, Restorative Therapies Group, and Minimally Invasive Therapies Group, and above-average growth within its Diabetes Group.

Diabetes in particular is a key part of the equation as it is the only segment expected to grow above the corporate average. As I detailed in a report last year, this is also the segment that investors are most excited about after the company's launch of the 670G, the first hybrid closed-loop system on the market. 

CGM is a Key Part of the Diabetes Growth Plan

The company recently presented a more comprehensive overview of its plans for the Diabetes Segment at the American Diabetes Association. One key topic was Medtronic's focus on standalone continuous glucose monitors (CGMs).

Source:  MDT ADA Presentation   Note: Red highlight is my own.

Source: MDT ADA Presentation

Note: Red highlight is my own.

Management will be more focused on the CGM market and multiple daily injection (MDI) patients going forward, as they believe the market will grow from $1B today to $2B - $3B within the next several years.  Medtronic detailed its plans to fill gaps in its CGM, the Guardian 3, and for its next generation CGM, the Harmony 1. The gaps include:

Non-adjunctive label: Medtronic plans to file a PMA later this year for non-adjunctive labeling. Currently, the Guardian 3 device only has labeling as an adjunctive device - it must be used to complement, but not replace, information obtained from standard blood glucose monitoring devices. As a complementary device, this means that the Guardian 3 cannot be considered a primary tool for managing diabetes, and therefore does not fall under the requirements to be covered by Medicare. Once Medtronic receives non-adjunctive labeling, the company will be able to market to an additional 20% of pump users through Medicare coverage.

Auto calibration: Currently, the Guardian 3 requires a user to use a fingerstick to calibrate the device. In contrast, the Dexcom G6, recently launched in early June, auto calibrates and therefore does not require a fingerstick. This makes the device significantly more convenient to users. Investors believe the Harmony 1 will be factory-calibrated and will therefore eliminate the need for fingerstick use.

iCGM: In March, the FDA introduced a new set of criteria for integrated CGMs to be classified as "moderate risk" class II medical devices. This allows manufacturers to bring CGMs to market more quickly without the more extensive review associated with "high risk" class III devices. As of now, Medtronic believes that they cannot fully meet the standards of an iCGM, but will be working towards it likely by FY2019 - FY2020. With iCGM classification, timelines for products such as the 690G (detailed next) could potentially be moved up. 

In terms of timelines, investors believe that non-adjunctive labeling could come in CY2019 and prove to be a catalyst to G3 sales. Beyond that, investors also believe that the Harmony 1 (with auto calibration) could potentially launch in CY2020. 

670G the Gem in the Diabetes Segment, but Competitors Are Coming

Additionally, Medtronic gave a detailed update on its 670G device. Recall that the 670G is the primary component of the company's plans going forward. Insulin pumps are still only used by about 20-30% of type 1 diabetic patients after numerous years on the market. Many analysts continue to hold the view that the 670G will grow pump penetration more rapidly given the significance of its improved functionality. If the company is able to hold onto its share of the market (70%+) and pump penetration continues to grow (as it is expected to), the company could add a significant amount of patients to its user base and grow revenue significantly.

Currently, Medtronic has onboarded about 100,000 patients out of a customer base of about 450,000 onto the 670G. Investors look for this to continue to grow rapidly driven by 1) increased pump penetration among Type 1 diabetic patients, 2) upgrading existing users from older versions of its pump, 3) more value-based relationships with insurers such as United Health (detailed later), and 4) taking customers from Animas. On the latter point, recall that Animas recently decided to exit the pump market, leaving 90,000 users on the market for a new pump. 

Medtronic also provided an update on its value-based partnership with United Health. Management noted that its share of diabetic patients using pumps had grown from 70% to 92%, while United patients using a Medtronic pump had a 27% reduction in hospitalizations and a 14% reduction in medical costs. Most of these patients were also on the older 630G or 530G devices; results would likely be even better with patients on the 670G. Given the strong economic benefits to insurers, partnerships could prove to be very effective in accelerating pump adoption and growing Medtronic's share within the pump market.

Increased adoption of the 670G should also lead to stronger sensor sales and margin performance. Medtronic shared data showing that the 670G has grown sensor attachment, with 65% of users using a sensor vs. 35% prior. The increased adoption translates to an annual revenue uplift per customer of about $3K (from $5K to $8K). Given the high margins, this could meaningfully contribute to the company's annual 40-50 basis point margin expansion target.

Looking ahead, Medtronic is racing to become the first manufacturer to an artificial pancreas. The company recently enrolled its first patient in an auto correction bolus trial. With the 670G covering closed-loop basal insulin delivery, getting closed loop bolus insulin delivery would represent the next step towards the goal of an artificial pancreas. Investors believe that the company can potentially file the 690G by the second half of 2019.

The timeline is becoming increasingly important as competitors are nipping at their heels. Medtronic continues to believe that they hold a 2+ year advantage over competitors, as the company continues to hold the best in class pump with the 670G. However, the advantage appears to be narrowing. Tandem plans to launch a hybrid closed loop device in CY1H19, while Roche, Lilly, Bigfoot Biomedical, Betabionics, and Insulet all have plans to launch hybrid closed loop pumps by CY2020/2021.

Source:  MDT ADA Presentation   Note: Red highlight is my own.

Source: MDT ADA Presentation

Note: Red highlight is my own.


Monitor the Diabetes Segment as Outperformance Would Derisk Financial Targets

Looking across the street's estimates, most brokers are currently modeling MDT achieving 4% total organic revenue growth, with roughly 3-4% organic growth across the majority of its business segments, and double-digit organic growth at the Diabetes segment. As a result, it will be crucial for the company to continue to drive adoption of the 670G and maintain its pace of innovation within the segment to hit its long-term targets and for the stock to outperform.