Earnings Preview: Zimmer Holdings (ZMH)

Zimmer Holdings (ZMH) is scheduled to release its second-quarter 2010 earnings on July 22, 2010. The Zacks Consensus Estimate for the quarter is $1.05 per share, representing a year-over-year growth of 5.5%.

Previous-Quarter Highlights

Zimmer’s first-quarter fiscal 2010 earnings per share (EPS) of $1.02 were a penny ahead of the Zacks Consensus Estimate and surpassed earnings of 91 cents per share in the comparable quarter last year. Revenue in the quarter increased 7.1% year over year to $1.06 million.

Barring Spine Products (7% decline to $60 million), growth was witnessed across all business segments at Zimmer. On an annualized basis, growth was recorded at Reconstructive Implant (7% increase to $814.5 million), Orthopedic Surgical Products (22% to $76.2 million), Trauma (6% to $60.4 million) and Dental (9% to $51.7 million).

Reconstructive Implants is the largest segment at Zimmer, which contributed 77% of the company’s total worldwide revenue. The product volume/mix for the reconstructive business accounted for 4% of growth, the highest level experienced since the third quarter of fiscal 2008, when volume/mix trends were consistently in the mid to high single digits.

Agreement of Analysts

Over the last 30 days, 1 of the 22 analysts covering the stock has made a downward revision to the estimate for the quarter ended June and 1 has made a downward revision over the last 7 days. Moreover, 1 analyst has made an upward revision over the last 30 days, thus providing no directional movement for the company’s earnings in the June quarter.

We note that for the third quarter, only 1 analyst out of 21 has increased the estimate in the 30 days. The Zacks Consensus Estimate for the third quarter is $1.00 per share. The analysts are negatively biased for fiscal 2010, as 2 of the total 25 analysts reduced their estimates, both in the last 30 and 7 days, while only 1 analyst increased the estimate in the last 30 days.

Along with the first-quarter results, Zimmer also updated its outlook for 2010. Adjusted EPS guidance remained unchanged at $4.15–$4.35 and revenue was projected to increase between 3% and 5% on a constant currency basis. The company expects mid single-digit domestic year-over-year growth for the reconstructive division with slight growth in Europe and flat growth in Asia Pacific. The company is also optimistic about key hips and knees franchises belonging to the reconstructive division in fiscal 2010 through new product introductions.

Zimmer will likely face pricing pressures, as is evident from the first quarter when the consolidated average selling price collectively declined 0.7% year over year. For fiscal 2010, the company expects 1%–2% price erosion.

However, the orthopedic procedure volume stabilized and saw some improvement during the first quarter. We believe the decline in pricing will be offset by an improvement in procedure volume growth driven by resurgence in the macro economy.

Magnitude of Estimate Revisions

The magnitude of revisions is moderate following the first-quarter results. Overall, estimates for the second quarter have gone down by a penny to the current level of $1.05 per share in the last 90 days. For fiscal 2010, estimates remained consistent at $4.26 per share, after increasing by a penny over the past 3 months. A similar trend can be seen for 2011, with estimates remaining consistent at $4.70 per share, after increasing by a penny or two in the last 90 days.

Surprise

Going by past trends, we expect Zimmer to exceed estimates since its earnings exceeded expectations in the past four consecutive quarters. The company has a positive four-quarter average of 29.43% which implies that on average, Zimmer Holdings has topped the Zacks Consensus Estimate by 29.43% over the last four quarters.

Our Recommendation

Zimmer has a solid portfolio of reconstructive and spine products as well as broad global distribution capabilities, which should lead to improved performance over time.

Currently, we have a Zacks #4 Rank on the company, as we remain concerned about pricing pressure in the short term. Zimmer is also exposed to threats from intense competition and currency fluctuation as about 42% of the company’s total revenue is generated from international operations. Despite these headwinds, we expect Zimmer to capitalize on an improved industry scenario and its strong product portfolio. As a result, on long-term perspective we have a Neutral recommendation on the stock.

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