2023-12-18 12:44:04 ET
Summary
- ZBH reported strong 3Q23 performance and has provided a positive business outlook.
- The company's new innovations and increasing presence in ambulatory surgery centers (ASCs) are driving growth.
- GLP-1 should be a tailwind for ZBH, extending its long-term growth runway.
Summary
Following my coverage on Zimmer Biomet Holdings, Inc. ( ZBH ), which I recommended a buy rating as ZBH's 2Q23 performance was very strong, and the business had a visible growth outlook (increased FY23 guidance). This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for ZBH as the business outlook remains very strong, backed by positive traction in new innovations and an increasing presence in ASC (ambulatory surgery centers). GLP-1 is also a tailwind that should extend ZBH's long-term growth runway. The upcoming analyst day could be a catalyst to drive valuations upward.
Investment thesis
ZBH 3Q23 revenue was reported at $1.754 billion, up 4.7% on an organic basis, beating consensus estimate of $1.749 billion. Knee sales saw $706 million, up 7.3% organically, and Hip sales saw $465 million, down 0.6% organically. That said, both Knees and Hips saw traction with new product launches that I believe are increasing ZBH's exposure to higher-growth end markets. In the P&L statement, EPS saw $1.65, beating consensus by $0.05.
While y/y organic growth was down on a sequential basis in both the Knee and Hip segments, I still expect growth to remain healthy given the strong execution that management has demonstrated. Specifically, the continued success in delivering on innovation and improving presence in ASC channels should continue to drive growth. Regarding innovations, ZBH is seeing nice traction for Rosa, which is now gradually penetrating the Hip segment. Using Stryker Corporation ( SYK ) as a relative comparison (more premium implants), I see ZBH's growing Rosa penetration as a positive mix-shift driver of growth as penetration increases.
Regarding improving its presence in ASC channels, ZBH has significantly increased its investments in this area, both in terms of personnel and portfolio, over the last couple of years in response to the ongoing movement of its knee and hip patients to the surgery center setting. In comparison to SYK, ZBH has always been grossly under-indexed in the ASC channel. For reference, only about 10 to 15% of ZBH sales are to ASCs presently. I expect ZBH to be more and more well-positioned for the mix shift to ASC setting, that I expect to continue over the next few years, as the recent investments begin to pay off (management covered this in detail over the last few calls; I encourage readers to listen to them). It is also worth mentioning that ZBH is experiencing strong momentum with Rosa's placement in the ASC channels. This bodes well for future demand on the implant side.
Migration is, I think, what we're seeing here in the US with a rapid shift of cases more into an ASC, while also preserving what are very compelling volume levels in the traditional inpatient and outpatient settings.
The reasons behind the market profile the market growth profile and why I continue to say this market is different than four, five years ago are the things that I alluded to in my prepared remarks, the explosion of ASCs, their movement, the shift to ASC is real. 3Q23 earnings results call .
One of the major topics lately is GLP-1. While I am not a subject matter expert regarding this, my thoughts are that GLP-1 is going to be a tailwind for ZBH. Firstly, GLP-1 is not a cure or remedy for what ZBH is addressing. Secondly, GLP-1 reduces the tendency toward obesity, which lifts the hurdle for joint surgery. As management cited, obesity is a blocker today because many surgeons are uncomfortable operating on patients with a high BMI. Thirdly, if GPL-1 works out well, it extends the lifespan of patients, which theoretically increases the addressable market for ZBH as the number of potential procedures will increase as well. Longer lifespan > more movements + old age increases the chance of injuries, etc. > more procedures.
One interesting case study that management brought up during the call was Japan. Japan is the second-largest market for osteoarthritis procedures worldwide. It is a common fact that the Japanese have a very long lifespan, and that fact contributed to more procedures. Importantly, Japanese obesity rates are minimal.
Looking ahead to FY24, management anticipates mid-single-digit revenue growth, outperforming the market in each division, with earnings growing faster than revenue. The upcoming analyst day could be a strong catalyst as management intends to discuss long-term plans. Personally, I see a path for high-single-digit growth given the end-market growth strength, portfolio innovations gaining traction (i.e., Rosa mix shift impact), strong pricing, and strong backlog that will be digested in FY24.
Groundbreaking technologies are shaping how procedures are done. Beyond the backlog and continued favorable demographics, global demand for treatment is higher than it has historically been.
We believe we spend a lot of time going back on for some backlog that is going to remain here throughout the end of '24 at least, but we are not a backlog depending -- backlog-dependent type of company, so we don't we're not focused on that.
So there's been a lot of back and forth in terms of what's going to happen once the backlog is out and all that. First, the backlog, we don't think is going to be out anytime soon, and then pricing is sustainable. 3Q23 earnings results call
Valuation
Own calculation
My target price for ZBH remains largely the same at $157.87. My growth estimates for the next 2 years remain at 7%, which is consistent with management's 7% constant currency growth guide. I am making a more aggressive assumption because of the visible growth drivers I mentioned earlier. However, what was very clear in management guidance was their confidence in driving up margins, emphasizing that they will grow faster than revenue. This reinforces my view that margins will improve. As ZBH stabilizes its gross margin (which is its management focus), it should start to benefit from a larger scale (operating leverage), driving earnings margins upward. Overall, I still think ZBH should trade at 17x forward P/E (its 5-year historical average) given its better business position, strong growth tailwinds and pricing, and its strong execution. The catalyst to drive valuation upwards could be the upcoming analyst day when the market will gain more insights into its growth outlook.
Risk
M&A is a strategy that ZBH remains focused on. While this could help accelerate innovation, the risk is that management overpays for an acquisition, which will be value-destructive for shareholders. This would also disrupt the organic growth equity story of ZBH, impacting valuation.
Conclusion
I continue to recommend a buy rating for ZBH. Despite a slight sequential decline in organic growth in the Knee and Hip segments, I expect growth to remain at a healthy pace given the positive traction with Rosa and ZBH's increasing presence in the ASC channel. I also see GLP-1 as a growth tailwind as it potentially expands ZBH's market.
For further details see:
Zimmer Biomet Holdings: Visible Growth Drivers And Strong Execution