Zimmer Holdings: Earnings Preview

| About: Zimmer Biomet (ZBH)

Zimmer Holdings (ZMH) is scheduled to release its third-quarter of fiscal 2010 earnings on October 28, 2010, before the market opens. According to the Zacks Consensus Estimate, the company is expected to report EPS of 95 cents, (representing a year-over-year growth of 8.5%) on $995 million of revenue.

Previous-Quarter Highlights
Zimmer reported an EPS of 82 cents during the second quarter, down 16.3% from 98 cents in the second quarter of 2009. However, adjusted EPS (excluding anticipated charges associated with the suspension of an artificial hip replacement component) was $1.09, beating both the Zacks Consensus Estimate of $1.05 and the year-ago quarter’s $1.00.

Zimmer reported net sales of $1.06 billion, in line with the Zacks Consensus Estimate but declined 3.7% from the year-ago quarter’s $1.20 billion. Growth was seen across all the geographical segments, during the quarter, with continued enhancement of most of the company’s product lines.

Barring Spine Products (10% decline to $57.9 million), all of Zimmer’s business segments registered improved performance. On an annualized basis, growth was recorded at Reconstructive Implant (4% to $808.2 million), Orthopedic Surgical Products (16% to $77.9 million), Trauma (2% to $57.8 million) and Dental (6% to $55.9 million). Consistent with the first quarter, Reconstructive Implants Segment revenue comprised 76% of the total revenue.

Zimmer reiterated its sales and adjusted EPS guidance for fiscal 2010. Revenue is expected to grow between 3% and 5% on a constant currency basis. Adjusted EPS is expected in the range of $4.15 to $4.35.

Agreement of Analysts
Estimate revision trends among the analysts reflect a negative bias for the company’s earnings in the September quarter. Over the last 30 days, 5 of the 24 analysts covering the stock have lowered their estimates for the third quarter while 3 made upward revisions. Over the past week, 1 analyst has increased his estimate without any revision in the opposite direction.

We note that for the fourth quarter, 4 analysts out of 24 have reduced their estimates in the last 30 days with one moving in the opposite direction. There seems to be negative opinion hovering over fiscal 2010, as 7 of the total 27 analysts decreased their estimates in the last 30 days without any upward revision.

The bearish sentiment for the upcoming period year reflects the macro concerns related to pricing pressures and unfavorable foreign exchange movements. Pricing pressure on Zimmer was evident from the first quarter itself when the consolidated average selling price collectively declined 0.9% year over year.

For fiscal 2010, the company expects 1%–2% price erosion, but volume and mix are expected to balance the effect. Zimmer expects the Asia-Pacific region to witness decline in pricing in the remaining half of fiscal 2010, primarily due to price cuts in Japan, which came into effect on April 1, 2010.

The orthopedic procedure volume has stabilized during the second quarter. However, we remain cautious until evidence of a better economic environment and improved procedure volumes begin to materialize.

Magnitude of Estimate Revisions
The magnitude of revisions is moderate following the second-quarter results. Overall, estimates for the third quarter have gone down by a penny to the current level of 95 cents in the last 90 days. For the fourth quarter of 2010, estimates remained consistent at $1.20 per share, despite decreasing by a penny over the past 7 days.

For fiscal 2010 and fiscal 2011, estimates remained consistent at $4.26 and $4.69, respectively.

Going by past trends, we expect Zimmer to surpass estimates since it has exceeded expectations in the past four consecutive quarters. The company has a positive four-quarter average of 3.01%, which implies that, on an average, Zimmer has topped the Zacks Consensus Estimate by 3.01% over the last four quarters.

Our Recommendation
Zimmer has a solid portfolio of reconstructive and spine products as well as broad global distribution capabilities, which should lead to improved performance over time. The fundamentals underlying the orthopedic reconstructive industry remain strong and we believe that the company still has the potential for positive mix-shift and contend that an aging global population, obesity, proven clinical benefits, new material technologies, and innovation in surgical techniques will drive the company in the long term.

The company is on its way to achieving market growth through new product launches, employment of new technologies and expansion of its footprint in the growing Chinese market. We expect the company to recover its market share losses as well as achieve an above-average operating leverage going forward.

Currently, we have a Zacks #4 Rank on the company, as we remain concerned about pricing pressure in the short term. Zimmer is also exposed to threats from intense competition and currency fluctuation, as about 42% of the company’s total revenue is generated from international operations.

In addition, Zimmer is highly dependent on the Reconstructive Implants segment (mainly hips and knees, which represent 30% and 43%, respectively, of total revenue), from which it earns 80% of total revenues. Despite these headwinds, we expect Zimmer to capitalize on an improved industry scenario and its strong product portfolio. As a result, on a long-term perspective, we have a Neutral recommendation on the stock.

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Tagged: , Medical Appliances & Equipment, Earnings
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