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  • Important disclosures appear on the last page of this report. P a g e 1

    Krause Fund Research Spring 2017 Healthcare Recommendation: HOLD Analysts

    Wenzhe Zhang Wenxiong Ye Wangye Xu

    Company Overview Medtronic Plc, formerly Medtronic Inc., is the worlds leading medical technology and Service Company. They develop, manufacture, and market a wide range of medical devices, therapies and services for the treatment of diseases such as heart disease, spinal conditions, neurological disorders, vascular disease, orthopedic disorders and diabetes. Medtronic reported a revenue of 28.8 billion in the FY2016. Stock Performance Highlights 52 week High $89.27 52 week Low $69.35 Beta 0.85 Average Daily Volume 4.6 m Share Highlights Market Capitalization 110 b Shares Outstanding 1.39 b Book Value per share $36.08 EPS (FY2016) $2.51 P/E Ratio 28.37 Dividend Yield 2.15% Dividend Payout Ratio 60.56% Company Performance Highlights ROA 3.86% ROE 7.90% Sales $28.8 b Key Management Ratios Current Ratio 3.29 Debt to Equity 0.6 Inventory Turnover Ratio 2.38 Total payout ratios 140.55%

    Medtronic Inc. (NYSE: MDT)

    April 18, 2017

    Current Price: $80.36 Target Price Range: $82.00-$87.00

    Investment Thesis We believe that Medtronics current market leadership in medical devices, favorable in industry trends and stable revenue growth will be beneficial to Medtronic future growth. Based on the DCF model, we think Medtronics stock is fairly priced, and consequently we issue a HOLD rating for Medtronic. Investment Positive Favorable demographics in aging: The global aging population increases the demand for medical devices as older people tend to have more chronical diseases and actively seek for medical treatment. Favorable demographics in income: The rising middle class population also contributes to the increasing demand for medical devices. As people get wealthier, they have a higher possibility of getting hypertension and other related diseases due to changing lifestyles. Potential deregulation and tax cut: Even though the appeal of Obamacare has failed. But that doesnt mean there wont be major policy changes in the future. We still believe Trumps deregulation and tax cut in general as promised during election. Diversified product lines: Medtronic has over 10 mergers over the past two years. These mergers has helped diversify Medtronics product lines. Investment Negative Rising competition: Medtronic faces rising competitions in high-tech products from not only domestic competitors, but also foreign companies such as Siemens from Germany and Hitachi from Japan Continuing Pricing Pressures: Medtronic also faces pricing pressures from hospitals as the hospitals are trying to control their capital expenditures. One Year Stock Performance

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    Executive Summary Medtronic Plc, a Dublin-based company, is a leading medical technology and equipment firm with multiple product lines in the health care supplies & service industry. Based on the DCF model, we think Medtronics stock is fairly priced, and consequently we issue a HOLD rating for Medtronic.

    Macroeconomic Outlook Gross Domestic Product Gross Domestic Product (GDP) is a measure of the value of all goods and services produced by an economy in a given year. It reflects the productivity and purchasing power of an economy and therefore has a significant influence on the confidence of both consumers and businesses. One of the major component of GDP is government spending. Since the early 1980s, the U.S. has been the largest healthcare spender in percentage of GDP, and the healthcare expenditure in percentage of GDP has steadily grew since 1980, from around 9% in 1980 to 17.8% in 2015. The growth rate has been stable since the year of 2009, fluctuating around 17% of total GDP. Therefore, GDP is a good metric for healthcare sector.

    Source: Centers for Medicare and Medicaid Services [1] Real GDP is inflation-adjusted GDP. As to March 2017, the real GDP is 1.9%, which is relatively stable compared to previous months, fluctuating around 2%. We predict the real GDP growth rate will continue this trend and fluctuate around 2%. Even though the U.S. economy is recovering from the 2008 financial crisis, we are reluctant to give a higher growth rate regarding the uncertainty of Trumps economic policies.

    Source: U.S. Bureau of Economic Analysis [2] Demographics Demographics refers to the study a specific population group based on factors such as age, sex and others. It reflects the characteristics of a certain group of population and therefore can be used in policy development and market research. Demographics in age and income are important factors that drive the growth of the U.S. healthcare sector. In 2015, people aged 65 and over accounts for 14.9% of U.S. population and are expected to grow to 22.1% by 2050. Additionally, the percentage of people aged 80 and over is 3.8% of total U.S. population and is expected to grow to 8.2%1. As more and more people age, the demand for healthcare increases because older people tend to have more chronical diseases. These chronical diseases are usually hard to treat in nature, which encourages healthcare companies to spend more money on research and development in order to find a treatment.

    Source: US Administration on Aging As income keeps increasing, more and more people enter middle class. In 2030, the middle class is estimated to constitute 65% of world population. The increase in income will gradually change peoples lifestyle and can potentially cause many chronical diseases such as hypertension, diabetes and obesity. As a result, the demand for long-term healthcare will increase too. The shrinking poor people also marks that more people will gain access to healthcare.

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    Source: Brooking Institution Government Regulation The U.S. healthcare sector is heavily regulated both at state and federal levels. The health insurers, the retail pharmacies, the physicians and the hospitals are usually overseen by the state government. Medical device and drug manufacturers and distributors are regulated by the federal government. The major federal regulatory agency is the Food and Drug Administration (FDA). Manufacturers must obtain Food and Drug Administration (FDA) approval of their products before they can sell them in the U.S. and export them abroad. The approval of medical devices are relatively easier compared to pharmaceuticals because they do not need to go through a stringent review before commercialization. But the process could still take a long time due to documentation and examination. The oversea regulatory environment for healthcare products vary among countries. In general, developed countries such as Japan, Australia and most of the European countries because they share similar protocols. Specifically for EU countries, individual firm only need to get one approval from EU to operate in all EU countries. However, our team is worried about how Brexit will influence the exports of healthcare to EU countries. We predict that the exports pf healthcare to Britain in the following years will be more difficult as individual firm will have a gain a separate approval. Capital Markets Overview The U.S. healthcare sector is an appealing area for investors. Even though this sector is heavily regulated by the government and experience continuous pricing pressures, the market keeps growing and new products keeps emerging. Additionally, the Trump

    Administration has failed in appealing Obamacare. In the short run, we believe that there wont be any major policy changes in the healthcare sector. Therefore, our team believes that it is a good time to invest in the healthcare sector.

    Industry Analysis Industry Overview Our team identifies Medtronic in the Healthcare Equipment & Supplies industry. The healthcare equipment & supplies industry consists of companies engaged in manufacturing and distribution of medical equipment and supplies. It is segmented on the basis of product lines by the U.S. Census Bureau for the purpose of estimating the size and shape of the industry. The segments are as follows:2

    In-Vitro Diagnostic Substances Manufacturing: It includes chemical, biological or radioactive substances used for diagnostic test performed in test tubes, Petri dishes, machines and other diagnostic test-type devices.

    Electro-medical and Electrotherapeutic Apparatus Manufacturing: It includes pacemakers, patient-monitoring systems, MRI machines, diagnostic imaging equipment (including informatics equipment) and ultrasonic scanning devices.

    Irradiation Apparatus Manufacturing: It includes X-ray devices and other diagnostic imaging as well as computed tomography equipment (CT).

    Surgical and Medical Instrument Manufacturing: It includes anesthesia apparatus, orthopedic instruments, optical diagnostic apparatus, blood transfusion devices, syringes, hypodermic needles and catheters.

    Surgical Appliances and Supplies Manufacturing: It includes artificial joints and limbs, stents, orthopedic appliances, surgical dressings, disposable surgical drapes, hydrotherapy appliances, surgical kits, rubber medical and surgical gloves, and wheelchairs.

    Dental Equipment and Supplies Manufacturing: It includes dental hand instruments, plaster, drills, amalgams, cements, sterilizers and dental chairs.

    Ophthalmic Goods Manufacturing: It includes eyeglass frames, lenses and related optical and magnification products.

  • Important disclosures appear on the last page of this rep