Medtronic's disappointing earnings highlight challenge posed by currency headwinds

Med tech revenue growth in 2015



Comparable, constant   currency basis 

(FY 2015)






C.R. Bard



Boston Scientific



The column on the right excludes the impact of exchange rate fluctuations and M&A activity, such as Medtronic's takeover of Covidien.

Source: Company earnings releases

The dollar's rise against the Chinese renminbi, euro and a broad basket of other currencies has crimped U.S. corporate profits, and the med tech industry is no exception (see table). Bloomberg Intelligence  last year estimated that the stronger dollar will cut U.S. medical device company earnings by an average of 6%. And with fears of another renminbi devaluation, a rise in U.S. interest rates and global "currency wars," the problem could get worse.

One cue, the role of exchange rates was the dominant topic of Medtronic's ($MDT) recent earnings call. The company's stock fell almost 4% following its Q3 FY 2016 earnings report because the company's adjusted operating margin was below expectation due to currency headwinds, according to company officials. The metric stood at 27.8%, below the company's guidance of 28% to 28.5%.

Despite reassurances, Wall Street is still wondering whether the miss was due to a lack of synergies from the $50 billion acquisition of Covidien, according to Jefferies equity analyst Raj Denhoy, who told Fortune, "Right or wrong, it (adjusted operating margins) is the number that investors are looking at to judge the integration of Covidien, as a marker for how well the expenses are being controlled." 

Analysts were also concerned about a slight slowdown in U.S revenue growth during the quarter, which stood at $3.96 billion (a 4% year-over-year increase and a slight decline over the prior quarter), and questioned whether the impact of currency devaluations was strong enough to offset the suspension of the medical device tax.

Apparently, it was. Medtronic CFO Gary Ellis said the unadjusted operating margin was 29.4%, "but this improvement was completely offset on a reported basis by a negative 140-basis-point impact from foreign currency."

Medtronic officials also said U.S. market is steady, and that the company will exceed the promised $300 million to $350 million in annual synergies from the Covidien deal.

Gary Ellis, Medtronic chief financial officer and executive vice president

They insisted the miss was solely due to negative headwinds from foreign currency exchange rate fluctuations.

When questioned again, company officials specifically cited the 30% devaluation of the Argentine peso, which resulted in an unexpected $21 million expense.

And limiting the effects of such devaluations on earnings and margins by hedging against the rising dollar via financial market contracts with banks only becomes more challenging the longer the greenback rises against foreign currencies.

"While we hedged the majority of our operating results in developed market currencies to reduce volatility in our earnings from foreign exchange, a growing portion of our profits are unhedged, especially emerging market currencies, which can create modest volatility in our earnings," Ellis said.

Toward the end of the call, Denhoy asked why Wall Street should feel comfortable with Medtronic's Q4 operating margin guidance of 31% to 31.3%.

"Again, I wish I could predict currency and be able to tell you that there's not going to be surprises positive or negative on the currency side," Ellis responded.

Medtronic expects a $200 million headwind in FY 2017 from exchange rate fluctuations (presumably devaluations) due to the loss of significant hedging gains in FY 2016 and continued pressure from unhedged emerging market currencies. 

Moody's just cited the strong dollar (as well as weaker hospital admission trends) as one of the reasons for downgrading the device industry's outlook from positive to stable. It expects the dollar to rise against the euro Japenese yen and Chinese renminbi through 2017.

Moody's senior credit officer Diana Lee said in a statement that, "We expect the strong US dollar to continue to weigh on medical device companies' earnings over the next year or so, but not as much as in 2015."

- read the earnings release
- here's Fortune's take 
- here's more from Moody's 

Editor's Note: This article has been updated with information from Moody's.