Image Source: Zimmer Biomet
The outperformance of the medical devices industry continues unabated in 2017. The momentum underscores that the steep sell-off in the second half of 2016 was likely an overreaction. We’re updating our previous take of Zimmer Biomet, along with a brief earnings update on Edwards Lifesciences and Intuitive Surgical.
By Alexander J. Poulos
Zimmer Biomet Continues to Perform
Shares of Zimmer Biomet (ZBH) came under heavy selling pressure upon the release of its recent earnings report on April 27, but we were content with the update as its diversified revenue stream continues to perform, in our view. Zimmer is in the process of integrating recent acquisitions, which continue to augment revenue, and the top line advanced 3.8% in the first quarter; acceleration is expected in the second half of 2017. Management updated earnings guidance for the year, which in our view, underscores the expected acceleration of business in the second half of this year. We are pleased with the targeted earnings range, which was increased to $4.68 to $4.88 on a diluted basis versus the previous forecast of $4.37 to $4.67 per share.
We recently highlighted Zimmer in a piece titled, “Looking closely at Zimmer Biomet” back in early January of this year. At the time of publication, the equity was trading at its recent lows, well below our fair value estimate of $120+. While Zimmer sold off upon the recent earnings release, the equity has enjoyed a stellar run since our initial publication, so we’re not too disappointed. In fact, we’re pleased to see the share price regain some of the ground lost from the dramatic post-earnings sell-off, too.
That said, however, while we like Zimmer Biomet, we continue to have shares of Medtronic (MDT) in the Dividend Growth Newsletter portfolio. Unfortunately, the lack of a meaningful dividend from Zimmer has precluded it from consideration for the Dividend Growth Newsletter portfolio, but that could change. Still, we remain enamored with Zimmer Biomet’s growth profile, and our team has it high on the watch list for inclusion into the Best Ideas Newsletter portfolio. Sustained accelerated revenue growth would help with in the decision-making process.
TAVR Growth Accelerates at Edwards Lifesciences
We remain in awe of the stellar performance of Cardiovascular Device specialist Edwards Lifesciences (EW) since the beginning of 2017. Shares of Edwards came under intense selling pressure in the third quarter of last year as a delay in procedures roiled revenue recognition for the industry. However, we remain leery of chasing momentum plays without substantial valuation support. Shares of Edwards Lifesciences aren’t on sale, in our opinion.
That said, Edwards has an enviable position in the area of Transcatheter Aortic Valve Replacement (TAVR). TAVR is a minimally invasive procedure where a qualified physician can repair a damaged valve in the heart. The procedure is a welcome advance as it bypasses the need for open-heart surgery, which requires the chest to be opened up to reveal the heart, allowing for the removal of the damaged valve. The opening of the chest leads to a substantial recuperation period—thus, a minimally-invasive procedure should gain favor.
Edwards is the current market leader due to its significant first-mover advantage. While we acknowledge the well-entrenched leadership position of the company in TAVR, competition is picking up, however, most notably from Dividend Growth Newsletter portfolio holding Medtronic. The fear of loss of market share from heightened competition did not manifest itself during the recent earnings release posted April 25, as Edwards’ share price zoomed over 10%. Its equity is now trading well above the top end of our fair value range. Its valuation isn’t great, but we continue to monitor performance.
da Vinci Systems Continue to Power Growth at Intuitive Surgical
Intuitive Surgical (ISRG) continues to accelerate higher on the heels of an impressive quarterly earnings report, released April 18. Powering the equity higher has been the continued market adoption of the da Vinci system, which incorporates robotic technology to aid in surgical procedures. From our perspective, the main attraction continues to be the minimalization of incisions, which rapidly improves healing time.
Intuitive does not profit strictly from selling the initial machine–a very lucrative parts business is formed with every installation. We like the razor-razor blade model employed by Intuitive–each surgery requires new equipment that is exclusively provided by Intuitive. The power of the business model has been on full display, with the recent earnings release showing equipment sales accounting for over half of the company’s revenue.
Our concern with Intuitive, however, parallels our caution with the valuation of the overall market. Equities, in general, are not cheap, and while we rate the Economic Castle of Intuitive as “Highest Rated,” our top grade, the equity is trading well above our fair value range. It had previously been included in the Best Ideas Newsletter portfolio, but we’re not going to be adding it back “up here.”