Zimmer Holdings: Implanted Value
Stocks of companies that make artificial joints and reconstructive implants have been aching lately. Although the aging of the huge baby-boom generation virtually assures that demand for orthopedic products will remain robust, the industry faces pressure from hospitals that want to pay less for medical devices, as well as from proposed cuts to Medicare reimbursement for surgical procedures.
But this negative sentiment toward orthopedics appears overblown, say analysts at Morgan Stanley. "We continue to see incremental evidence of stabilization in the orthopedics market," they said in a recent report to clients.
The analysts say that the sell-off in the shares of Zimmer Holdings (symbol ZMH) represents a particularly good buying opportunity. Zimmer, the world's largest orthopedic-implant firm, began in 2001 as a spin-off of Bristol-Myers Squibb. The Warsaw, Ind., company makes reconstructive and spinal implants, as well as trauma-related surgical products.
During the first quarter of 2006, Zimmer's income grew 18%, to $206 million, and earnings per share of 82 cents were a penny ahead of analysts' estimates. But revenue missed Wall Street's expectations because of slack sales in Europe, and the company's profit outlook for the second and third quarters was lower than analysts anticipated. Zimmer said it expects sales to accelerate in the second half of 2006 with the launch of a hail of new products. But investors remained skeptical, and shares tumbled 6% after the first-quarter news. Zimmer's stock, currently at $61, is down 27% from its 52-week high of $84, reached last September.
Although pressure from hospitals to lower the costs of orthopedic devices makes for a more challenging pricing environment, overall demand for implants remains strong, says analyst Gregory Aurand of Zacks Equity Research, who recently upgraded Zimmer to a buy. "Pricing issues appear less onerous," Aurand writes.
At the end of April, Zimmer reached a five-year deal to supply hospital chain HCA. "This agreement trades discounts for achieved market share and growth," said Ray Elliott, Zimmer president and chief executive officer, in announcing the agreement. Multi-year contracts that Zimmer has inked with other hospital buying groups allow for purchasing of new technologies that carry price premiums.
Zimmer's long list of products set to launch this year includes ceramic and metal hip products, as well as a line of knee implants specifically designed for women. The company expects these new products to help boost revenue growth by 10% to 11% in the second half of 2006, verses the year-earlier period. For the full year, Zimmer expects sales to grow 9% to 10% above 2005 revenues of $3.3 billion, and earnings per share to grow 16%, to $3.40.
The shares, at $61, trade at 18 times analysts' 2006 earnings estimates of $3.39 per share and 16 times 2007 estimates of $3.89 per share. Analysts at both Zacks and Morgan Stanley believe the stock is worth $75.