At the start of this year, I called the products and solutions of Zimmer Biomet (NYSE:ZBH) healthier than the stock as an actual investment. The business has been struggling, in fact, operating stagnant for years, essentially since the tie-up between Zimmer and Biomet, leaving valuations rather demanding.
Irony will it that in the year in which GLP-1 drugs made their breakthrough, Zimmer has actually seen a strong operating performance. This makes the shares look compelling given the lackluster share price developments, creating appeal, but many of its peers in the medical device and pharmaceutical sphere have sold off even more, which means that I will take a wait-and-see approach.
Creating Perspective
Zimmer Biomet was created when both firms combined their operations in 2014 as Zimmer acquired Biomet in a $13.3 billion deal. Already a $100 stock at the time, shares rallied to the $130 mark in 2016 with investors pricing in anticipated benefits from the deal.
The idea was to create a giant in the musculoskeletal industry, with larger scale and cross-synergies seen between key areas like knee, hip implants, spine, dental, etc. The pro forma business was set to create $7.8 billion in sales, with closing taking place in 2015.
The combination was set to post earnings close to $8 per share as that looked appealing in relation to a $100 share price, although that adjusted earnings were quite adjusted and the gap with GAAP earnings was substantial. With realistic earnings coming in a bit lower, the earnings multiple expanded to a market multiple as net debt of $11 billion worked down to a leverage ratio just over 3 times based on EBITDA of $3.5 billion.
Ever since it has been a period of essentially stagnation with 2021 revenues of $7.8 billion being on par with 2016, despite the fact that the company operates in long term growth segments. Shares peaked around $170 per share during the stock market rally in 2021, as shares fell back to the $125 mark early in 2023.
This was based on sales seen down to $6.8 billion in 2022, with revenues down due to the spin-off of ZimVie (ZIMV), representing the dental and spine operations of the business. Earnings were seen down to $7 per share (adjusted earnings). The only promising thing, amidst a flattish to slightly higher share count vs. the period of the acquisition, was that net debt has come down to $5 billion and change.
With 210 million shares trading at $125, equity was valued at $26 billion, for a $31 billion enterprise valuation. This valued the business at 4.5 times sales of $6.8 billion and 18 times adjusted earnings, not creating any great reason to get involved despite a bolt-on deal being announced at the start of the year.
Expectations Come Down Again
A $125 stock at the start of the year peaked at nearly $150 per share in the summer, but by now has fallen back to $113 per share, after shares even traded near the $100 mark in recent weeks.
In February of this year, Zimmer Biomet posted full year sales of $6.94 billion, up less than 2% compared to 2021, although a strong dollar hurt reported sales growth by five percent. Adjusted earnings were reported at $6.89 per share. Moreover, GAAP earnings only came in at $1.38 per share, as some ten adjustments between both earnings metrics were made. Net debt was reported at $5.3 billion by year-end. The guidance for 2023 only called for stagnation with reported sales seen up at a midpoint of 2.5%, as adjusted earnings are seen flattish between $6.95 and $7.15 per share.
The company provided an impressive hike in the full year guidance following the release of the first quarter results with reported sales for the year now seen up 5-6%, with adjusted earnings seen between $7.40 and $7.50 per share. This guidance was hiked to 6.5-7% sales growth alongside the release of the second quarter results, with adjusted earnings seen between $7.47 and $7.57 per share.
The company maintained the earnings per share guidance alongside the release of the third quarter results, while the full year sales outlook was cut by fifty basis points, entirely due to adverse currency moves. In the meantime, net debt was pretty flat at $5.2 billion.
And Now?
With shares down to $113 per share here, the market value of the firm has fallen to $24 billion, and the enterprise value to levels around $29 billion. With revenues now trending at around $7.3 billion per annum and adjusted earnings seen around $7.50 per share, valuations looks much more reasonable at 15 times adjusted earnings while leverage comes down further.
This is seen in the light of high single digit constant currency growth, and while this performance is solid, it comes as the long term stagnation is clearly seen, which makes it hard to develop conviction here even if valuations trade at a small discount to the market.
Despite the solid performance so far this year, there is one big elephant in the room, that is the group of GLP-1 drugs, which, if weight loss become a near term but dominant theme, is that it could weigh heavily on demand for Zimmer’s products in the future. If people carry less weight, it might hurt demand for notably knee and hips products, key markets for Zimmer Biomet.
Amidst all this, I am taking a wait-and-see approach with shares of other medical device manufacturers and pharmaceutical names having come down even more, although I am impressed by the pace of sales growth this year. This growth stands in contrast to the long term stagnation, making me question how strong and what the longevity of the growth is.
Given all this, I am taking a cautious stance here, as I am waiting for more clues about growth in 2024 and the impact of GLP-1 drugs on the sector at large.
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