2023-08-11 18:56:58 ET
Summary
- Health Care sector ETF (XLV) has underperformed the S&P 500 by 15 percentage points but has shown a modest revival in the last month.
- Zimmer Biomet had a solid earnings report and raised its 2023 revenue and earnings guidance, indicating potential growth.
- Technical risks exist, but the stock's valuation appears decent, and there is a possibility of earnings upside.
- I outline key price levels to watch following the stock's downward earnings-related move this month.
The Health Care Select Sector SPDR Fund ETF (XLV) is flat on the year. Compared to the S&P 500, the defensive niche has underperformed by about 15 percentage points, but there has been a modest revival in XLV relative to SPY in the last month. With an uptick in some big names, like Eli Lilly (LLY), a positive turn could be on the way. One name had a solid earnings report, but shares traded sharply lower this month. I assert the selling was overdone.
I have a buy rating on Zimmer Biomet (ZBH), though I acknowledge that there are technical risks.
Health Care Stocks Turning Up vs. SPX
According to Bank of America Global Research, ZBH designs, develops, manufactures, and markets orthopedic implants (hips, knee trauma, and craniomaxillofacial) as well as related orthopedic surgical products.
The Indiana-based $26.1 billion market cap Health Care Equipment industry company within the Health Care sector trades at a high 52.0 trailing 12-month GAAP price-to-earnings ratio and pays a small 0.8% dividend yield, according to Seeking Alpha. Shares carry a low short interest of 1.5% while implied volatility is modest at just 18% after reporting earnings earlier this month.
Back on the first of the month, Zimmer Biomet issued a modest bottom line beat while top line results were also solid. Per share profits were $1.82 (non-GAAP) on Q2 revenue of $1.87 billion, up 5% from the same period last year. What was bullish was that the management team raised its 2023 revenue and earnings guidance. Its 6.5% quarterly revenue growth beat the street and spoke of margin expansion in 2024 on the call.
The firm sees an improved product mix in 2024 and reduced pricing pressure next year which should foster consistent profitability growth. Despite tougher comparisons, strong operating leverage is now expected to result in higher EPS growth over sales growth, though this year's Q3 is expected to have lower gross and operating margins due to seasonal factors while the final quarter of the year is projected to have the highest operating margin of 2023.
Upside catalysts could stem from faster growth from its COVID-induced backlog, faster adoption of its pipeline of products, and any favorable M&A moves. Key risks include a slowdown in hip/knee replacements, margin pressures, less favorable trends in robotic enhancements, and execution risks.
On valuation , analysts at BofA see earnings rising at a solid pace this year before per share profit growth steadies just under 6% in the out year through 2025. The Bloomberg consensus forecast is about on par with what BofA projects. Dividends, meanwhile, are expected to rise steadily over the coming quarters. With a mid-teens forward operating P/E and an EV/EBITDA ratio that is below that of the broader market, the valuation appears decent on the surface while Zimmer Biomet's free cash flow yield is above the S&P 500's average.
Zimmer Biomet: Earnings, Valuation, Dividend Forecasts
As earnings growth balances out in the mid-single digits, the forward valuation becomes easier to determine. While the stock has an "F" factor grade, I assert that there are some reasons to like how ZBH is priced today. If we assume the next 12-month operating per share earnings of $7.70 and apply the company's 5-year historical non-GAAP P/E, then we are talking about a $150 stock. Compared to the Health Care sector, shares are at an even steeper discount. Though 2022 EPS dropped, we are near trough earnings it appears, which also warrants a higher P/E.
ZBH: Mixed Valuation Signals, But Cheap on Expected EPS
Seeking Alpha
Compared to its peers, Zimmer Biomet has comparable profitability figures and decent share price momentum - though I will highlight why the technical momentum situation is not all that appealing right now. But with solid EPS revisions , there is a real possibility that earnings upside is on the way. Its similar-sized med tech peers trade at about 20 times 2024 EPS, so my valuation is on the conservative side. It's conceivable that the fair value could be near $160 based on the 20x multiple on close to $8 of operating EPS.
Peer Comparison
Looking ahead, corporate event data provided by Wall Street Horizon shows an unconfirmed Q3 2023 earnings date of Wednesday, November 1 BMO. No other volatility catalysts are expected over the coming weeks.
Corporate Event Risk Calendar
The Technical Take
Zimmer Biomet had been a very strong performer from the middle of last year through this past June. Relative strength gains have been surrendered, though. Notice in the chart below that ZBH found resistance at an old point of polarity. The $150 to $155 area had been a support during the first half of 2021 but then became resistance once the price gapped down in August of that year.
After failing to climb back above that range, the stock continued its bear market dive, eventually finding a floor at $100 13 months ago. The bulls took charge, and the stock climbed above $120 as the long-term 200-day moving average flattened. A 50% rally off the low stalled at noted resistance, and another big earnings downside gap eventually resulted in ZBH dropping under its 200dma for the first time since last November.
Today, I see support at $120 while the $150 to $155 area remains the resistance. With a very poor oversold RSI momentum reading at the top of the chart confirming weak price action, the bears have gotten a grip on this Health Care stock, and there is high volume this month. The good news for the bulls is that the 200dma remains positively sloped, but $120 is important to hold. Overall, the chart is neutral to slightly bearish.
ZBH: $120 Support, $100 Under That. $150 Key Resistance.
The Bottom Line
Despite a concerning chart, the valuation is strong with ZBH. I have a buy rating and would add to the stock on an approach of $100.
For further details see:
Zimmer Biomet: Guidance Raise, Better Margins In 2024 Make It A Buy