It plans to soon introduce the NexGen Flex Mobile knee, which is said to allow more natural joint rotation, and the Gender Solutions joint system, a knee implant specifically tailored to a woman's smaller joint. Innovations like those help explain why Zimmer has been posting double-digit growth in knee sales, which account for 42% of the company's total revenue.
Frost & Sullivan, Thomson Reuters
Three at the top: Zimmer, Stryker and DePuy have more than two-thirds of the artificial hip and knee markets, which are growing as boomers age.
THE OUTLOOK FOR HIPS, while generally upbeat, is a bit less certain. This business, which accounts for 31% of company sales, increased 10% in the most recent quarter, and that pace is expected to continue in the immediate future. Sales should be helped by new gender-specific hip system (about 60% of hip-replacement patients are women), plus a new hip-stem implant that promises to conserve more bone than existing offerings.
But there is a problem. Zimmer, unlike rivals Smith & Nephew and Stryker, has yet to offer a product for hip-resurfacing, a less-than-total replacement operation. Resurfacings are increasingly popular among younger, more active patients and may end up accounting for 8%-to-10% of hip operations. Zimmer's resurfacing product isn't scheduled to launch before 2011, a couple of years behind early expectations.
Though knees and hips remain Zimmer's main growth drivers, the company also makes dental and spinal implants. But all these products face one major challenge: society's ability to pay for the procedures. Medicare and top insurance companies are pushing to cut reimbursement rates, which will pressure profits of hospitals and eventually trickle down to the manufacturers in the form of lower prices. A knee replacement often runs $35,000, while hips go for about $40,000.
ZIMMER, HOWEVER, IS in a strong position to take on this challenge. Thanks in part to leading-edge manufacturing technology, its operating profit margins are now among the industry's best, at close to 30%, and could be headed significantly higher.
Ever since it was spun off from Bristol-Myers Squibb in 2001, Zimmer has generated strong cash flows, equal to about 20% of sales. Those have financed a slew of acquisitions, most recently last year of ORTHOsoft, a Canadian company that designs and markets top medical software, instruments and computerized systems to help orthopedic surgeons increase accuracy in hip, knee and spine implant surgery.
Zimmer also bought Endius, a company that has developed breakthrough, minimally invasive spine-surgery products, implants and techniques to treat spine disease.
The Bottom Line:
Zimmer's shares, knocked down by an industry faux pas, could climb by more than 25%, as demand builds and the company launches innovative products.
Now, with the pace of acquisitions slowed, the company is using its cash to buy back stock at a higher rate, a move that clearly reflects management's view that the company is trading at a discount to what it is really worth.
At its recent price around 70, Zimmer stock was changing hands at 16.5 times estimated '08 earnings of $4.20 a share and about 14.5 times '09 projections of around $4.77 a share. Both multiples are well below its historic peaks in the high 20s. Given the continued longer-term growth prospects, the company's high margins and its position in the industry, this valuation seems on the low side.
Certainly, the company can count on selling at least one more knee. When Gutowski visited me immediately after my surgery, the first thing he mentioned was that the damage to my right knee was far worse than he'd expected. On that basis, he forecast that my left knee would need replacing within 24 months.
