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Agreement of Analysts

Following the release of first quarter fiscal 2011 results of Zimmer Holdings (NYSE:ZMH) on April 28, 2011, estimate revisions by analysts have moved in both directions for the second quarter. However, expecting a gradual recovery in terms of procedure volume in the second half, estimates revisions are on the positive side.

Previous quarter highlights

Zimmer Holdings reported an EPS of $1.08 during the first quarter of fiscal 2011 compared with $1.01 in the year-ago quarter. However, after considering certain adjustments, the EPS was $1.19, surpassing the Zacks Consensus Estimate of $1.12 and $1.02 in the first quarter of fiscal 2010. Revenues increased 5% year-over-year to $1,116 million (3.3% at constant exchange rates, CER) during the quarter and beating the Zacks Consensus Estimate of $1,093 million.

Zimmer’s biggest segment, Reconstructive Implant, recorded a 3% increase in revenue to $842 million driven by growth in Asia Pacific (16%), Europe (3%) and Americas (1%). While revenues from Knees (within Reconstructive) remained unchanged at $462 million, Hips and Extremities recorded a growth of 7% to $337 million and 12% to $43 million, respectively.

Among the other segments at Zimmer, barring Spine which declined 5% to $57 million, growth was witnessed across all other businesses including Surgical and Other (10% annually to $84 million), Trauma (16% to $70 million) and Dental (21% to $63 million).

Zimmer reiterated its outlook for 2011. The company expects to report adjusted EPS of $4.60-$4.80 (reported basis: $4.25-$4.45) on revenue growth of 2%-4% at CER. Currency movement is expected to boost revenues by 3% thereby giving way to the reported revenue growth of 5%-7%.

Following the release of first quarter results, estimate revision trends among analysts reveal a mixed opinion on the company’s earnings in the second quarter. Over the last 30 days, 7 of the 26 analysts covering the stock have made upward revisions for the second quarter of fiscal 2011, with equal revisions in the opposite direction.

Procedure volumes in the musculoskeletal market during the reported quarter were stable relative to the fourth quarter but were lower than the normal level of growth. Economic recession in the US resulted in declining enrollment in private health plans among people under the age of 65.

Consequently, a number of potential joint replacement patients had to defer their treatment. Due to the extension of COBRA benefits, these deferrals did not significantly impact trends at a macro level till the second half of 2010.

Moreover, total patient population declined with the rise of uninsured population due to increase in unemployment levels. However, Zimmer expects the growth rate of procedure volume in the US to recover in the second half of 2011.

Furthermore, Zimmer experienced -0.9% of pricing pressure in the first quarter, a stable trend compared to the previous quarter and in line with its expectations. The recent disaster in Japan is going to have a negative impact of 1% on total sales in 2011.

In line with the company’s expectation of recovery in the second half of 2011, analysts have raised their estimates for fiscal 2011. 21 of the 29 analysts covering the stock have increased their estimates with none moving in the opposite direction. While Zimmer expects its Knee and Hip businesses to be affected by slower market growth through the second quarter, the situation is likely to improve in the second half based on easier comparisons.

Although the musculoskeletal market is witnessing several challenges in the form of reduced procedure volume and pricing pressure, Zimmer believes that clinically relevant and innovative products can still fetch premium pricing and reimbursement. For the past few quarters, Zimmer has been investing in its product portfolio. The company recorded a 10% year-over year increase in R&D expenses during the quarter which will rise further with the expansion of product development and clinical programs.

In order to streamline its business, Zimmer has adopted restructuring initiatives and diverted the savings for further investment. Over the last quarter, the company has made significant progress in its restructuring and transformation efforts with the completion of a management de-layering initiative.

Additional initiatives include consolidation of sourcing activities and optimization across its global manufacturing network. Based on a strong product portfolio and other strategies undertaken by Zimmer, the analysts are optimistic on a long-term basis.

Magnitude of Estimate Revisions

The magnitude of revisions is modest following the first quarter results. While the estimate for the second quarter has gone up by a penny to $1.19 over the last 30 days, for the third quarter, it remained unchanged at $1.06. Based on the long-term outlook of the company, which should benefit from an improving economy, estimates for 2011 and 2012 have gone up by 6 cents each to $4.76 and $5.23, respectively.

Recommendation

Zimmer offers a broad line of reconstructive implant and trauma products, as well as orthopedic surgical instruments and supplies. The company is on a growth trajectory with new product launches, employment of new technologies and expansion into the emerging markets.

However, Zimmer continues to witness challenges in the form of pricing pressure and lower procedure volumes resulting from economic uncertainty. Moreover, the company faces tough competition from players such as Stryker (NYSE:SYK) and Johnson & Johnson (NYSE:JNJ). In order to streamline its business, Zimmer plans to continue with its global restructuring program.

We maintain our ‘Neutral’ recommendation on the stock, which also corresponds to the Zacks #3 Rank (hold) in the short-term.

Source: Earnings Scorecard: Zimmer Holdings