Covidien LEAPS: A Good Investment?

Covidien Ltd. (NYSE: COV) shares may be trading well off of their 52-week highs, but some investors believe the medical equipment maker may be overdue for a rally. Barron’s Online recently published an article highlighting the firm’s improving fundamentals, low multiples, and mountain of cash, calling it a quality stock for uncertain times. So, is now the right time for investors to pick up shares in this company?

Covidien was originally a spin-off from troubled conglomorate Tyco Internation (NYSE: TYC) and now stands as one of the world’s largest makers of disposable medical products and a leading surgical equipment maker with annual sales of $10 billion. After years of neglect, Covidien’s efforts to improve profitability and its pipeline are starting to pay off. Management continues to execute with good earnings visibility over the next year given the stability of the business.

In September, Covidien announced that it would implement a restructuring program beginning in fiscal 2009 to improve its cost structure and deliver improved operational growth. The program will result in a pre-tax charge of $200 million in the beginning in the first quarter, but will save $50 million to $75 million on an annualized basis while complete. Howevever, sales themselves are doing very well with 2008 sales expected to come in at the high end of their original forecast.

Covidien is set to report its next earnings on November 17th with analysts estimating $0.68 per share on the average. However, the company has beat estimates for the past four quarters with earnings surprises ranging from 5.7% to 12.6%. Meanwhile, trading at a PE of just 17x and a PEG ratio of 1.08, many investors are hoping that continued surprises will help to jump the share price to a higher 20.8x multiple that its medical equipment peers are seeing.

Investors looking to get into Covidien without committing much capital and limiting risk may be interested in the LEAPS on the stock. The Covidien January ‘10 $45 calls are currently trading at just $7.30 per contract. This means that investors can purchase the right to acquire 100 shares at $45 per share, anytime between now and January 2010, for just $730. This compares to a cost of $4,451 if the stock were purchased now. Maximum losses are also capped at just $730 while gains are leveraged up.

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