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Zimmer Holdings (ZMH) is a leader in knee and hip implants and plays in a number of other orthopedic niches. The company was added to the idea pipeline as Morningstar rates it a 5-star wide moat company. ZMH’s stock is currently trading at $51-52.

1- Business Performance Risk (=) and intrinsic returns (=)

Metric

Status

FCF / Sales

Last twelve months: 25%, historically has been between 13% and 25%

ROE

LTM: 11.8%, ROE has been constantly declining over the last 5 years from 17.4% to 12.7% as of 12/2009.

ROA

LTM: 8.8%, similar to ROE, ROA has been declining steadily over the last 4 years from 14.7% down to 9.6% last year

Revenue Growth

Over the last 3-5 years, ZMH has been growing at 5%-6%, but has experienced an essentially flat 2009 and is now back growing a bit with a TTM performance of 3%.

Cash distribution to shareholders

ZMH does not pay a dividend!

Over the last 5 years, the company has bought about 17% of its stock back

ZMH’s business model seems less robust than I expected from a MedTech company with a leading position in some of its markets. While it generates a high level of cash, returns have been declining steadily over the last 4 years. Note that returns are “artificially” low, given $3bn or so of intangibles on the company since 2003 (seems ZMH overpaid for an acquisition back then!).

In terms of returns:

- ZMH does not pay a dividend (which I find disappointing for a mid-low growth high ROE company),

- ZMH could finance a 5% growth with about 30% of its earnings (using a 15%+ ROE and taking intangibles out of equity)

- ZMH has another 70% of earnings to buy back shares or increase cash on the balance sheet. At the current earnings yield of 6%, ZMH could buy back ~5% of its stock back.

This leaves us with an OK intrinsic return of ~10%

2- Balance Sheet Risk (+)

Metric

Status

LT Debt / Equity

0.2x

Current Ratio

5.0x

Very limited risk with low debt and high current ratio

3- Valuation Risk (=)

Metric

Status

Cash Return

10.1%

P/E

15.9x, higher than the 13.7x of the S&P 500 and lower than the company’s average over the last 5 years (19x)

Valuation is a bit mixed, with an interesting cash yield but a somewhat high P/E ratio

Conclusion

Zimmer seems to be a good company. While returns appear to be on the low end, they are much more attractive when “corrected” for the amount of good will on the B/S resulting from an acquisition 7 years ago. The company is between a stalwart and a low grower at this point with growth of 5-6% but is not paying a dividend which is disappointing.

Looking at valuation while the cash returns could be interesting, the P/E for now tells a bit of a different story and I fear that current valuation may not leave an investor with enough margin of safety to compensate for some of the questions around the business. I will pass for now but would reconsider performing a company analysis ZMH if its price were to come down to low 40’s or its earnings improve making its P/E more attractive, or the company initiates a dividend).

Disclosure: No position

Source: Zimmer Holdings: Nothing to Get Excited About