You Gotta Have Heart Cardiac-care stocks are recessionproof but volatile.
By Duff McDonald

(MONEY Magazine) – Saying nice things about cardiac-care companies is easy. Their products keep you alive--can't beat that for a slogan. And they cater to well-off, well-fed, aging markets in North America and Western Europe where health-care safety nets protect the companies from global deflation and domestic recessions. "If your doctor says you need a pacemaker," says Ken Kam, manager of Firsthand Medical Specialists fund, "you aren't going to wait for interest rates to come down to get one."

Adding to the companies' stock market appeal is innovation: New markets can be created overnight. Only a few years ago an angioplasty--in which clogged arteries are opened--used as its primary device a $500 balloon-tipped catheter. Enter the stent--a tiny scaffold that supports artery walls, keeping passages clear and precluding, or at least delaying, the need for future angioplasties. Now cardiologists use a balloon and a stent or two, adding about $2,300 to the procedure's price tag.

The cardiac-care industry's rapid growth, however, hasn't produced across-the-board success. Fierce competition means that investment decisions aren't as straightforward as, say, buying Intel to capitalize on semiconductor demand. Companies leapfrog one another technologically on a regular basis, and market shares can swing from 40% to 10% in a heartbeat. How you play this field depends on how much risk you can take.

The industry is divided into what Hambrecht & Quist analyst Robert Faulkner calls electricians and plumbers. Electricians regulate the heartbeat. Plumbers--the makers of balloon catheters and stents--try to keep the heart and arteries free of blockages.

The fastest-growing piece of the market belongs to electricians. Demand for implantable cardioverter defibrillators (ICDs), used to treat irregularly fast heart rates, is increasing 25% annually and should hit $3 billion in the next few years. The market for pacemakers, which treat slow heart rates, is more mature, and growing only 6% a year. But because patients often suffer from a range of faulty heartbeats, cardiac companies are pushing the ICD and pacemaker into a single unit that can identify the source of a problem and correct it. Guidant Corp. is already selling such a device.

The market for plumbing, already more than $3 billion a year, is growing 10% to 15% annually. And it's anybody's game. Behemoth Johnson & Johnson owned the stent market four years ago but fumbled away its lead.

The jockeying in individual product lines presents investors with a choice: You can go with the biggest companies, paying for their relative safety, or you can seek more growth--and take on more risk--by opting for smaller firms with hot technologies.

The overall industry leader is Medtronic, with $2.6 billion in annual sales. It's the No. 1 pacemaker manufacturer, holding nearly half that $2.5 billion market, and is No. 2 in defibrillators behind Guidant. And it's a favorite of investors. Steadily rising earnings have fueled a 600% return over five years. Medtronic hopes to make up ground in defibrillators when it releases a combined pacemaker/ICD by early 1999. But investors looking for what Kam calls the safe stock in a storm have to pay top dollar. At $56.50, Medtronic trades at 39 times 1999 earnings, or twice its growth rate.

Among the plumbers, Boston Scientific is by far the biggest, with a wide array of products and a huge sales force to sell them. A manufacturing glitch in the company's new stent hurt the stock in September, but Jeffrey Barnes of BancBoston Robertson Stephens thinks Boston Scientific can grab 30% of the $1.2 billion stent market by 2000. Trading at 23 times next year's earnings, Boston Scientific is cheaper than Medtronic, but that reflects the more intense competition in interventional products.

Wedged between the giants, with a hand in both of their markets, is Guidant. Already ahead of Medtronic in ICD sales, the company is making a push in pacemakers. In late September, Guidant announced it would acquire Intermedics, a competing pacemaker manufacturer, for around $800 million. Guidant also holds a competitive position in the stent market. At 29 times 1999 earnings, the stock isn't cheap, but Hambrecht & Quist's Faulkner thinks that the company can hold its own.

Far less expensive, and far smaller, is Arterial Vascular Corp. It has just $388 million in sales but holds the top spot in the stent market. "These guys are in the pole position," says Piper Jaffray analyst Arch Smith. True, but the company's dependence on one product makes it vulnerable. That explains why the stock trades at just 15 times 1999 earnings. It's also why Arterial Vascular recently spent $550 million to buy c.r. Bard's catheter business.

Cheaper still is downtrodden veteran St. Jude Medical. Its fortunes serve as a reminder that if a company's pace of innovation falls off, so will interest in its stock. At 13 times 1999 earnings, St. Jude is downright cheap, but it should be.