Why this biotech company has years of growth ahead

Zimmer Biomet, a leader in the worldwide market for hip and knee joints, enjoys a competitive advantage and has years of growth ahead, says Dr Mike Tubbs.

People are living longer across most of the world. The average life expectancy at birth in the 38 countries of the OECD, an association of developed economies, increased from 67 to 80 between 1960 2020. Japan had the highest life expectancy in 2020 – 85 – while the UK’s was 81.

Educated professional people tend to live longer than average, with a 25-year-old American graduate surviving a decade longer than a high-school dropout. As people age they experience joint problems that reduce mobility to the point where artificial joints are required, especially hips and knees. Ageing baby-boomers and the obesity crisis (around 40% of Americans are obese) are the key drivers of demand.

The leader in the worldwide market for hip and knee joints is Zimmer Biomet (NYSE: ZBH), with 33% of the market, followed by Stryker with 22%. The UK’s Smith & Nephew is in fourth place with 11%. Zimmer originally took the walking frame invented in Britain in the late 1940s, made some minor improvements and called the result a Zimmer frame. However, their product range today includes high-tech hip, knee, shoulder, elbow and ankle joints, along with various diagnostic tests. Zimmer also used to cater for dental and spinal problems, but these lower-margin products were spun off as a separate company, ZimVie, in March 2022.

A Covid-19-induced backlog

Zimmer and other artificial-joint suppliers were adversely affected by Covid-19 since many joint-replacement operations were delayed while hospitals were overloaded with Covid-19 cases. These delayed operations form a substantial backlog, which should add to revenue over the next few years. The effects of the pandemic are clear in Zimmer’s revenue, which fell from $8bn in 2019 to $7bn in 2020, but recovered to $7.84bn in 2021.

Knee and hip replacements are its top product category, with 2021 sales of $4.5bn. The next-biggest subsector is products and services relating to sports medicine, extremities and trauma (SET), with $1.73bn. The dental and spine category (now spun off as ZimVie) comprised $1bn; other products were worth $0.6bn. About 60% of sales were made in the Americas.

Zimmer enjoys an enduring competitive advantage over potential rivals owing to its intellectual property (notably patents) and high switching costs for surgeons. Surgeons must overcome a substantial barrier if they want to switch from one supplier to another because of the time needed to train and develop expertise in using the new company’s tools and procedures. During his study time the surgeon will not be earning and is likely to work more slowly when doing operations. The patient outcomes may well be less favourable during this period and this could affect the surgeon’s reputation.

Most surgeons also develop a close relationship with their supplier’s sales representative, since they will have taught the surgeon how to use the various special tools and will often have assisted in operations. Surgeons often choose to use the supplier that they encountered during their residency and then remain with that supplier – this helps Zimmer, the market leader.

Zimmer invested $497m, or 6% of sales, in research and development in 2021. This large investment adds to its competitive advantage by enabling the development of new and improved products at a faster rate than would be possible for a smaller supplier with lower sales.

Zimmer’s ROSA robotics platform, for instance, assists surgeons in planning and performing complex knee, hip and neurosurgical operations. It has introduced the world’s first and only “smart” knee implant (it tracks a patient’s walking speed and step count), as well as a camera-based artificial intelligence system that tracks and monitors the timing of all the processes involved in an operation.

Increasing investment in innovation

Zimmer Biomet share price chart

Zimmer, which has a market value of $23bn, made an operating profit of $780m (10% of sales) in 2021, with net earnings of $402m. Adjusted net earnings (excluding amortisation of intangibles, restructuring and other items) were $1.55bn. Diluted earnings per share (EPS) totalled $1.91, or $7.37 on an adjusted basis.

Results for the first half of 2022 show sales up by 2.4% year-on-year (6.4% when exchange-rate fluctuations are accounted for) and full-year guidance increased to diluted EPS for continuing operations (excluding the spun-off dental and spine division) of $6.70-$6.90. Net debt at the end of the second quarter was $5.6bn, or around twice adjusted Ebitda. Zimmer has been steadily paying down its debt over the last few years.

Analysts’ estimates for 2023 are for EPS of $7.14, which, at the recent price of $109, gives a 2023 price/earnings (p/e) ratio of 15.3 (14.1 for 2024). The annual dividend is $0.96, giving a yield of 0.86%. Bryan Hanson was appointed CEO in December 2017 and has been re-energising the company after the operational problems it suffered in 2016/2017. He has spun off ZimVie, driven a restructuring programme to improve operational efficiency and invested in innovation for long-term growth (particularly in digital and robotic products); competitiveness is improving.

The recent share price of $112 is 36% below $175, the fair-value estimate by investment research platform Morningstar, making Zimmer a value play on the expectation of sales increases from a rise in joint replacements now that the pandemic is receding. The demand for joint replacements is likely to rise in developed countries as baby-boomers age and obesity spreads. In developing countries, too, life expectancy is increasing and people want to remain mobile for longer.

SEE ALSO:

Recommended

Should I buy an annuity now? Annuity rates reach 14-year high
Pensions

Should I buy an annuity now? Annuity rates reach 14-year high

Retirees can now make their original pension pot back in 15 years, down from 22 years. We look at whether now is a good time to buy an annuity.
5 Oct 2022
The Burberry share price looks like a good bet
Trading

The Burberry share price looks like a good bet

The Burberry share price could be on the verge of a major upswing as the firm’s profits return to growth.
5 Oct 2022
What’s happened to Credit Suisse stock?
Bank stocks

What’s happened to Credit Suisse stock?

Credit Suisse stock has slumped on rumours that the bank is in trouble. Is there any truth in this speculation?
5 Oct 2022
Markets may have bounced, but this is not the end of the bear market
Stockmarkets

Markets may have bounced, but this is not the end of the bear market

Stocks are back on the rise, commodities and precious metals prices are up – even the pound has rebounded. But none of this is typical of bull markets…
5 Oct 2022

Most Popular

Should you take a 25% tax-free pension lump sum in instalments?
Pensions

Should you take a 25% tax-free pension lump sum in instalments?

Taking out a 25% tax-free lump sum sounds appealing but it might not be the best way to manage your pension
30 Sep 2022
Mortgage early repayment charges: are they worth the cost?
Mortgages

Mortgage early repayment charges: are they worth the cost?

With interest rates set to rise further in the months ahead, is it worth swallowing early repayment charges to refinance your mortgage today?
4 Oct 2022
Why the Bank of England intervened in the bond market
Government bonds

Why the Bank of England intervened in the bond market

A sudden crisis for pension funds exposed to rapidly rising bond yields meant the Bank of England had to act. Cris Sholto Heaton looks at the lessons …
30 Sep 2022