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On Aug 21, we maintained our Neutral recommendation on SurModics Inc. (SRDX - Analyst Report). SurModics reported in-line earnings in the third quarter of fiscal 2013 (ended Jun 30, 2013).

Why the Reiteration?

On Jul 31, SurModics reported 22% higher earnings in the third quarter of fiscal 2013 than a year ago. The year-over-year growth was primarily attributable to higher revenues.

Revenues climbed 2% year over year to $14.3 million. Increased sales of vitro diagnostics offerings and hydrophilic coatings were the primary reasons behind the year-over-year improvement.

Until fiscal 2011, the company operated through three business units: Medical Devices, Pharmaceuticals and In Vitro Diagnostics. However, in Nov 2011, SurModics sold the assets of the Pharmaceuticals division to Germany’s Evonik Industries AG for $30 million. From the first quarter of fiscal 2012, SurModics started reporting through two divisions - Medical Devices and In Vitro Diagnostics.

SurModics expects its In Vitro Diagnostic unit and hydrophilic coatings (of the Medical Devices segment) to continue performing well. Revenues from the In Vitro Diagnostic unit in the third quarter of fiscal 2013 were higher than a year ago. Segmental growth (the eleventh consecutive quarter of growth) was driven by strong sales of the company’s stabilizer and antigen products. Revenues from hydrophilic coating climbed 4% to $7.3 million in the third quarter of fiscal 2013. The third quarter of fiscal 2013 witnessed impressive hydrophilic royalty growth in the key sub-units of the medical device segment – neurovascular, peripheral, and transcatheter heart valve replacement.

We are positive on the steps taken by SurModics to increase efficiencies, including trimming its workforce and appointing a new Chief Executive Officer. Moreover, the company’s initiative to sell its Pharmaceutical unit to focus on its core business is a prudent move. In Dec 2012, SurModics appointed Andy LaFrence as its new chief financial officer and Vice President of finance. The appointment of LaFrence is expected to be beneficial to SurModics since he is vastly experienced in finance and capital markets.

However, since royalties are a major source of revenues at SurModics, any royalty related setback will affect the top line, such as the discontinuation of Johnson & Johnson’s (JNJ - Analyst Report) Cypher stent. We believe that the stock is fairly valued at current levels with limited scope for upside.

Other Stocks to Consider

While we prefer to remain on the sidelines on SurModics, other stocks operating in the same field which are worth considering are Hospira, Inc. (HSP - Analyst Report) and Alere Inc. (ALR - Snapshot Report). While Hospira carries a Zacks Rank #2 (Buy), Alere carries a Zacks Rank #1 (Strong Buy).

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