Zimmer Biomet's Valuation Offset By Lackluster Growth And Limited Near-Term Margin Leverage

Medical procedure volumes are gradually improving toward pre-pandemic levels, despite ongoing challenges with hospital staffing issues, and it’s time for Zimmer Biomet (NYSE:ZBH) to start delivering on the promises it has been making regarding leveraging R&D and improved go-to-market strategies to gain share in the ortho markets it serves and drive both attractive revenue growth and margin expansion.

I didn’t find a particularly compelling risk/reward opportunity with the shares when I last wrote about the company in early February of 2021, and with the shares down almost 25% since then (underperforming peers like Stryker (SYK) and the broader med-tech space), I don’t feel like I’ve missed out on much. While there have been signs of progress here and there, the reality is that the company’s performance in the ortho space on a two-year stack shows share loss in major joints.

I don’t think the valuation is particularly demanding if Zimmer can generate around 3% long-term revenue growth, mid-30%’s EBITDA margins, and high single-digit FCF growth. The real question, though, is whether or not the company can generate the sort of differentiated growth that will get investors to take a closer look – low-growth med-tech is a tough set-up for making money and I do have concerns that this could be a value trap.

 

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Zimmer Biomet's Valuation Offset By Lackluster Growth And Limited Near-Term Margin Leverage

Zimmer Biomet Sees Some Pandemic-Related Turbulence, But Continues Its Self-Improvement Drive

I was honestly pretty conflicted about Zimmer Biomet (ZBH) (“Zimmer”) when I last wrote about the company. The main source of my conflict was that I thought sell-side expectations of Zimmer emerging as a share-gainer in the orthopedic space (knees and hips, specifically) could be a little inflated, or at least premature, but the valuation wasn’t bad.

Since then, the shares have more or less matched the broader medical device space, underperforming Stryker (SYK), which I still think is a better company, and outperforming Johnson & Johnson (JNJ), which I think suffers from a split focus at the highest management levels. At this point, I’m still pretty ambivalent about the share price potential – the total return potential isn’t what I typically like to see, but it’s not bad on a relative basis, and I still see possibilities for Zimmer to outperform. All in all, I think it’s a story that will be driven by management execution, and so far that has been a favorable driver.

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Zimmer Biomet Sees Some Pandemic-Related Turbulence, But Continues Its Self-Improvement Drive

Hospitals Reopening, But Zimmer Biomet Needs To Stabilize Its Knee Business

I wasn’t overly fond of Zimmer Biomet (ZBH) back in early January, and the shares have modestly underperformed peers like Smith & Nephew (SNN) and Stryker (SYK) since then. The Covid-19 outbreak has certainly created an unexpected disruption for a business based largely around elective procedures, but I remain concerned about Zimmer on the more fundamental level of whether it can stop losing share to knee and hip competitors like Stryker and Johnson & Johnson (JNJ), and whether restructuring efforts can really improve the company’s long-term margin and growth outlook.

At the right price, I think the “better Zimmer” story might have legs, but today’s price looks more “okay” than compelling to me right now.

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Hospitals Reopening, But Zimmer Biomet Needs To Stabilize Its Knee Business

Zimmer Biomet Showing Long-Awaited Progress In Its Turnaround

Zimmer Biomet (ZBH) (“Zimmer”) has certainly had some issues since the acquisition of Biomet. Between integration challenges, manufacturing problems (including FDA warning letters), and slow underlying market growth, and other challenges to boot, the shares have dramatically lagged rival Stryker (SYK) and the medical device sector as a whole. The story over the past year is quite a bit different, though, as the shares have climbed more than 40%, beating even mighty Stryker, as CEO Bryan Hanson’s turnaround efforts have started to bear fruit.

From where I sit, the real question is the extent to which Zimmer can reignite organic revenue growth and drive better margins. Med-tech valuations tend to be driven by a blend of margins and revenue growth, and the latter is where Zimmer comes up a little short. Although I’m not particularly bullish on drivers like ROSA, Zimmer may yet have enough in the tank to beat revenue growth expectations and see further positive rerating. I’d call these shares more of a hold now, but one with improving underlying quality and upside if it can deliver that improved growth rate.

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Zimmer Biomet Showing Long-Awaited Progress In Its Turnaround

Wright Medical - No Fuss, No Drama, Just A Good Quarter

I’ve commented more than once recently that Wright Medical (WMGI) needs a run of steady, strong performance, and the March quarter was a good step in that direction. Revenue was good overall, gross margin was strong, and there wasn’t much that really needed explaining. What’s more, looking around the neighborhood, it looks like some of the competitive pressure has eased a bit, giving Wright Medical a smoother runaway to reestablishing reliable double-digit growth and its credentials as the leader in extremities.

With a quarter that offered few surprises, there’s not much to do on a modeling or valuation front, so I still think these shares deserve to trade closer to the mid-$30’s. The stock has been a little weak relative to the device space since the AAOS meeting, but I don’t see any near-term competitive concerns coming out of that meeting. While Wright Medical has earned a reputation for being more volatile than it probably should be, I do think the company is on a solid path now and represents a good GARP (“growth at a reasonable price”) set-up.

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Wright Medical - No Fuss, No Drama, Just A Good Quarter

Wright Medical Still Walking A Tightrope, But Growth Should Pick Up

Wright Medical (WMGI) has long been a challenging med-tech investment story. On the positive side, the company has been a share gainer in shoulders, still holds a strong portfolio (and market position) in foot/ankle, and is leveraged to an underpenetrated market that should support high single-digit revenue growth for some time to come. On the other hand, sales execution has been inconsistent at best, and the company is seeing renewed competitive vigor from rivals like Integra (IART) and Stryker (SYK).

On balance, I still think there’s upside in these shares from here, but management must execute on a consistent and reliable basis to build real long-term value for shareholders, and the jury is still out on whether they’re up to the task.

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Wright Medical Still Walking A Tightrope, But Growth Should Pick Up

Stryker Restores Its Growth Cred In A Big Way

Even though Stryker (SYK) had built an exceptional growth record, the shares had nevertheless underperformed going into the fourth quarter. I attribute that underperformance to worries about the company’s ability to maintain that impressive growth rate, with some investors choosing to view the supposed overtures toward Boston Scientific (BSX) as a sign of internal lack of confidence at Stryker, not to mention concerns about renewed vigor at rivals like Zimmer Biomet (ZBH). With strong fourth quarter results, and robust guidance for 2019, though, it seems like those concerns are at least momentarily moved to the back burner.

Stryker remains difficult to value, as I do believe the company’s high-quality growth deserves a premium, but arguably not that much of a premium. Healthcare tends to outperform later in the economic cycle and Stryker has a lot going on for it in 2019, but it’s tough for me to want to chase the shares around $180.

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Stryker Restores Its Growth Cred In A Big Way

Medtronic Steps Up With A Bigger Commitment To Robotics

Differentiation is the name of the game in the spine space today, and it seems clear that Medtronic (MDT) believes in the long-term future of robotics as a disrupting and differentiating opportunity. To that end, the company announced that it will be acquiring its partner Mazor (MZOR) in an all-cash deal that will give it full control over the future development of this leading robotics platform.

Even with the expected revenue re-acceleration in 2019 driven by the upcoming Mazor X Stealth (which brings integrated navigation to the robot), I believe Mazor is getting a fair price at over 18x estimated 2019 revenue. For Medtronic, while some investors may criticize the deal as buying the cow when they had already had a good deal in place for the milk, I believe total ownership of the platform and control over the future development path is worth paying for given the need to have a differentiated platform in the spine space today.

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Medtronic Steps Up With A Bigger Commitment To Robotics

Disruptive Innovation And Generally Good Execution Driving Globus Medical

Although there was a little hiccup in June, Globus Medical (GMED) has continued to outperform in a hot med-tech market, as investors have been fired up by the company’s disruptive innovation (particularly in robotics) and prospects to leverage meaningful share gains and pull-through in the coming years. At the same time, the company’s “core” spine business has continued to gain share in what may finally be a recovering U.S. market for spine procedures.

Up close to 80% over the past year, valuation remains my biggest concern with the shares. Ongoing beat-and-raise quarters should be able to support the stock (if not drive it higher), but the stock does appear to be carrying multiples in excess of what the business can support, and I believe that ups the risk.

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Disruptive Innovation And Generally Good Execution Driving Globus Medical

Wright Medical Getting Its House Back In Order

It’s tempting to make a “shot themselves in the foot” pun with respect to the problems Wright Medical (WMGI) got itself into over the last couple of years, but this extremities-focused orthopedics company does seem to be getting its house back in order. Not only should the approval and launch of the injectable form of Augment spur meaningful adoption growth, but the company’s shoulder business continues to perform very well, and it looks as though management has the traditional foot and ankle business back on track.

Wright Medical shares have given investors plenty of trading opportunities over the last few years, as the company has struggled to establish a consistent growth path after the Tornier deal. I believe the company is getting there, and I’ve been impressed with the company’s internal R&D engine. The shares do still seem to offer some upside, and over the long-term a buyout is still a possibility, but investors should appreciate that there is a history of inconsistent execution here.

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Wright Medical Getting Its House Back In Order

Stryker's Exceptional Growth Supports A Gravity-Defying Valuation

It’s difficult to find much comfort with Stryker’s (SYK) valuation, but the company continues to deliver exceptional financial results that at least help kick the valuation can a little further down the road. MAKO continues to drive share growth from Stryker in knee implants, while new power tools are driving strong surgical equipment growth, and the company continues to benefit from expanding penetration of interventional procedures for stroke patients.

I won’t try to justify the price Stryker is trading at today. Medical devices in general are trading well above long-term norms, but Stryker continues to deliver exceptional financial performance across its business units. I wouldn’t want to be caught without a chair when the music stops, but I know better than to assume that Stryker’s high valuation alone would prevent the shares from heading higher.

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Stryker's Exceptional Growth Supports A Gravity-Defying Valuation

Wright Medical May Be Hobbled Until The Ankle Business Re-Accelerates

Wright Medical (WMGI) shareholders didn't seem to be thrilled about the merger with Tornier, but looking back, it is the Tornier investors who probably have more to regret about that deal. Although backward-looking hypotheticals only get you just so far, it has been the shoulder business that Wright acquired in the Tornier deal that has been driving the business, while Wright's prior core lower extremity/ankle business has weakened considerably in the last two years.

I don't believe the lower extremity business is damaged beyond repair, but management absolutely has to execute better than it has and start regaining momentum versus rivals like Stryker (SYK) and Integra (IART) if the shares are to perform better. I'm still modeling long-term revenue growth in the high single digits and long-term FCF margins in the 20%s, which supports a mid-$20s fair value, but Wright Medical's weak execution makes this a "show me" stock at this point.

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Wright Medical May Be Hobbled Until The Ankle Business Re-Accelerates

Stryker Producing Excellent Results, But Expectations Are High

This year will be the 25th year I've followed med-tech (holy crap I'm old…), and Stryker (SYK) continues to amaze me. Apparently, Stryker never got the memo about "trees not growing to the sky" and the need to settle into a quieter middle age. In addition to pursuing growth-oriented M&A to augment existing businesses and address new markets, Stryker continues to do an excellent job of managing its long-held core businesses.

A business that performs as well as Stryker should command premium valuation, but how much of a premium? High single-digit FCF growth suggests an expected return of around 7% to 8%, and maybe that's not bad expected return/risk balance for a company like Stryker. Still, I believe the expectations are a little too high now, and I'd want a better expected return before buying in - even for one of the best-run companies out there.

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Stryker Producing Excellent Results, But Expectations Are High

Globus Medical Revving Up Into 2018

I’ve thought highly of Globus Medical (GMED), but I really didn’t expect the strength in the stock that the market has delivered since my last write-up. The shares have risen more than a third in a little more than six months and close to 80% in the past year, with the stock really taking flight after third quarter earnings. I believe at least some of this is due to Globus Medical offering pretty clean growth in a spine market where growth has become harder to find recently, not to mention the upside from the company’s entry into trauma.

It’s not all that comfortable to be on the negative side of a story with momentum, but I struggle to make the numbers work with Globus now. I do believe the company’s new robot platform, trauma products, and strong overall portfolio in spine can drive high single-digit revenue growth and double-digit FCF growth, but that’s already in the share price and I’m not comfortable paying more than 5.5x forward revenue. That being the case, I’ll be cheering from the sidelines for the time being.

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Globus Medical Revving Up Into 2018

A Sluggish Spine Market Keeping The Pressure On NuVasive

NuVasive (NUVA) is a case in point for a couple of things I've long believed about stocks. First, the process of revising earnings and expectations usually takes multiple quarters. Second, "buy on pullbacks" is actually hard advice to follow, as good companies don't often get all that cheap unless there are some legitimately scary (or at least nerve-wracking) issues going on with the company.

Although NuVasive shares eventually showed a little positive momentum after my last piece, the shares are down about 10% from that level now after another sell-off tied to the company's guidance at a major sell-side industry conference. With a less robust outlook for 2018, I've trimmed back my expectations some, but I still believe the shares are undervalued on the basis of long-term growth in the mid-single-digits. NuVasive has work to do to restore investor confidence, though, so I don't expect a sharp turnaround outside of an unexpected event like a buyout.

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A Sluggish Spine Market Keeping The Pressure On NuVasive

Stryker Still Rolling With The Punches

I believe there's a case to be made that Stryker (NYSE:SYK) is among the best-run med-tech companies in the last quarter-century, and maybe one of the best-run companies overall. Through multiple management transitions, numerous M&A transactions, and significant shifts in the med-tech landscape (in terms of technology, competition, reimbursement, etc.), this company has remained a surprisingly consistent grower and a good steward of capital. 

With that in mind, what's a fair price for this company? The shares dropped about 5% on the news of significant issues relating to Sage, but that decline has been almost fully recouped. The second-quarter results marked almost four straight years' worth of 5%+ organic growth and we're now talking about a new streak of close to 7% growth – for a company that is quite large already. I had actually hoped that the Sage news might open a wider window for more value anxious investors like me, but it's tough for me to get excited about buying the shares above the $130's.

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Stryker Still Rolling With The Punches

With Stryker, One Of The Best Always Seems To Get Better

Med-tech giant Stryker (SYK) isn't going to lead the pack every quarter or every year, but it's hard to argue with the long-term performance of this company. Better still, the company has never been one to rest on its laurels, with management always looking for ways to improve its existing businesses and branch out into adjacent markets.

Stryker doesn't look especially cheap right now, but that's about as surprising as Wednesday following Tuesday given the company's almost four-year run of mid single-digit organic revenue growth, its solid free cash flow generation, and the prospects to improve margins and drive better results from areas like robotics, imaging, neurovascular, and spine. I'm not an enthusiastic buyer at this price, but Stryker's quality gives it a near-permanent spot on my watch list, as the shares do occasionally sell off and come back down into a buyable price range.

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With Stryker, One Of The Best Always Seems To Get Better

Globus Medical Has Wobbled A Bit, But Still On Good Footing

Since I last wrote on Globus Medical (GMED) in March of 2016, “second tier” spine names have enjoyed a good run. K2M (KTWO), which I've liked more than Globus, is up a strong 85% and NuVasive (NUVA) is up more than 60%, but Globus too has rewarded my belief that it was undervalued with a roughly 46% upward move in the shares. What's more, given that Globus didn't exactly cover itself in glory in 2016 with respect to its organic revenue growth performance, I believe at least some of this move is a sector-wide shift toward a more positive view on the spine market and share-takers within that market.

Looking ahead, I don't see Globus as particularly cheap, but that's an increasingly common issue. I think Globus is back on track with respect to performing in line with its guidance, but I do worry that management could be stretching itself a little thin between its core spine business, its foray into robotics, and its new trauma business. I do still see opportunities for Globus to grow and gain share and it's not a bad hold at these levels, but I'd be tempted to wait in the hope of a pullback before building a substantial new position.

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Globus Medical Has Wobbled A Bit, But Still On Good Footing

Innovation And Execution A Powerful Combination For NuVasive

NuVasive (NASDAQ:NUVA) is a case in point as to why I'm a little cautious sometimes stepping away from strong growth stories driven by innovation and strong operational execution, particularly in markets/sectors that don't always have as much of those as they should. While NuVasive had a great run going into my last write-up in October, and did offer investors a brief pull-back, the shares have since climbed another 20% or so on the back of respectable financial performance and strong "in the field" innovation.

Valuation remains problematic. NuVasive is a relatively rare combination of good growth, strong margin leverage, and expanding market share, and I'm not surprised that it has become a popular go-to name in the space. That said, the shares are now pricing in a high teens FCF growth rate that may be hard to surpass. Given the history here of the market swinging too far during both the bad times and the good times, I'd be careful buying near the highs, but I'd certainly reconsider if the sector sells off on another bout of health insurance reform uncertainty and/or a company-specific shortfall in earnings/guidance.

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Innovation And Execution A Powerful Combination For NuVasive

Back To The Future With Wright Medical

As a shareholder, I'm pleased to see that Wright Medical (NASDAQ:WMGI) shares have done well since my last update after third quarter earnings. Management continues to do a good job running this business and there may well be legitimate underappreciated opportunities to outperform on the top line (new product introductions, share gains) and bottom line (better expense leverage) in the next few years.

Even so, it looks as though the Street is moving back to a "what if they get bought out?" sort of mentality, as the shares do seem to be factoring in quite a bit of growth and margin improvement from here. I don't like to bet against good management teams and good product stories, so I'm still content to hold tight with my position in Wright Medical, but I'd be a little more cautious about buying in on the assumption that a big M&A payday is right around the corner.

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Back To The Future With Wright Medical