INVESTMENT THESIS
We are reiterating our BUY rating on Zimmer Biomet Holdings Inc. (NYSE: ZBH) and lifting our price target to $170 from $160. The company’s ROSA robotics system is also helping it to gain new accounts among surgeons and hospitals.
RECENT DEVELOPMENTS
The recovery in procedural volume drove sequential improvement in Zimmer’s 3Q20 results (reported on November 6). However, management remains concerned that new waves of the pandemic may force hospitals and patients to defer procedures such as hip and knee replacements. In fact, management has noted that since the end of the third quarter, pressure on procedural volume has worsened in the EMEA region (Europe, the Middle East and Africa) as hospitals defer elective procedures in order to devote resources to COVID-19 patients.
Still, we believe that orthopedic volumes will normalize when the pandemic eases. These procedures, though elective in nature, are meaningful in improving the quality of life for older people. Moreover, Zimmer has filled gaps in its portfolio with a range of new products (e.g., cementless knee and hip joints, Persona brand knee implants for revision procedures) that should drive top-line growth. We also expect Zimmer to be more active in M&A than in the past, especially in acquiring businesses that improve the efficiency and lower the cost of orthopedic procedures (including pre-op preparations and post-op recovery and rehabilitation).
For the third quarter, adjusted EPS rose 2.3% to $1.81, beating the consensus estimate by $0.73. GAAP net income was $242.5 million or $1.16 per share, compared to $431.1 million or $2.08 per share a year earlier. Sales rose to $1.929 billion (+2.0% as reported; +1.1% on a currency-neutral or operational basis). Currency-neutral sales improved sequentially following a 38.0% decline in 2Q20.
By product category, worldwide sales of orthopedic knee implants totaled $648.7 million (-1.4% on an operational basis). Sales of hip implants were $484.1 million (+4.4%). Sales in the S.E.T. segment (Sports Medicine, Extremities and Trauma) totaled $359.9 million (+4.4%).
By measures of profitability, the adjusted gross margin was 70.6%, down 170 basis points. The adjusted operating margin was 26.3%, down 20 basis points.
The company launched the ROSA about 18 months ago, and has thus far placed more than 200 ROSA knee systems worldwide. Surgical utilization of the system is also increasing, with a current pace of 3,000 orthopedic cases per quarter, more than double the rate in 4Q19.
We see the ROSA system as an important clinical and technological differentiator as Zimmer competes with robotics platforms from Stryker and other companies.
Another differentiator is Zimmer’s collaboration with Apple in creating the MyMobility app for smartphones. The app enables users to engage with surgeons for pre-op preparation and post-op care. It also enables the collection and analysis of data on post-operative care that should help to improve outcomes over time.
EARNINGS & GROWTH ANALYSIS
Zimmer has not reinstated the 2020 guidance that it withdrew earlier this year. Still, management’s comments on the 3Q earnings call indicate a more upbeat outlook than during the 2Q20 call. Based on the company’s improved sales over the past six months, and our view that the worst of the procedural decline has past, we are raising our 2020 adjusted EPS estimate to $5.66 from $4.70. We are reiterating our 2021 forecast of $8.25.
FINANCIAL STRENGTH & DIVIDEND
The company has taken steps to bolster its financial flexibility and liquidity. It has refinanced a $1.5 billion credit facility and secured an additional $1 billion credit facility that will be in place through the calendar year.
As of the end of 3Q20, the debt/equity ratio stood at 69.8%, compared to 66.3% at the end of 4Q19. Cash flow from operations for the first nine months of 2020 was $779.4 million, compared to $1.162 billion a year earlier. The company expects margins, earnings and cash flow to improve as revenue recovers in 2021. We rate ZBH’s financial strength as Medium, the middle peg on our five-point scale. ZBH pays an annualized dividend of $0.96 per share, for a yield of about 0.7%. Our dividend estimates are $0.96 for 2020 and $1.00 for 2021.
RISKS
ZBH faces risks associated with developing new products and taking them through the regulatory review process at the FDA and other national regulatory agencies. Like other medical device companies, Zimmer also faces pricing pressures on a number of fronts, both in the U.S. and overseas. To counter these pressures, it has continued to introduce new technology and to reduce manufacturing and operating costs.
COMPANY DESCRIPTION
Based in Warsaw, Indiana, Zimmer Biomet is the nation’s largest pure-play maker of orthopedic devices. The company designs, develops and manufactures reconstructive orthopedic implants, including joint, dental and spinal implants; sports injury repair and trauma products; and related orthopedic surgical products.
VALUATION
ZBH trades at 17.9-times our 2021 EPS estimate, below the average multiple of 19.5 for our coverage universe of med-tech stocks. We believe this is an attractive valuation. The company’s ROSA robotics system is also helping it to gain new accounts among surgeons and hospitals.
On December 23, BUY-rated ZBH closed at $148.99, down $1.84.
Source: Argus
