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We recently upgraded SurModics Inc. (SRDX - Analyst Report) to Outperform from Neutral following its impressive results in the third quarter of fiscal 2012 (ended June 30, 2012). The stock carries a Zacks #2 Rank (Buy rating) in the short run.

SurModics’ third quarter fiscal 2012 adjusted earnings of 17 cents per share beat the Zacks Consensus Estimate of 13 cents. The earnings beat was attributable to higher-than-expected revenues. Strong sales from vitro diagnostics and hydrophilic coatings boosted revenues.

Encouraged by the strong performance, SurModics raised its forecast for fiscal 2012 on a reported basis. The company now expects to earn between 56 cents and 59 cents per share on revenues of $51 to $52 million. The previous guidance hinted at earnings between 45 cents and 53 cents on revenues in the range of $47 - $51 million.

The strong third quarter results prompted us to increase our fiscal 2012 and fiscal 2013 earnings estimates to 60 cents (up 9 cents) and 72 cents per share (up 9 cents), respectively.

Moreover, we believe that the share buyback program, announced by SurModics along with the results, of $55 million will increase shareholder value.

We are also pleased with the sale of SurModics’ Pharmaceuticals unit as this has allowed the company to focus on its core businesses. We note that performance of the company has been steadily improving since a disappointing fiscal 2010.

Following the disappointing performance in fiscal 2010, SurModics revamped its board of directors and appointed a new CEO, Gary R. Maharaj. We note that Maharaj is the former President and CEO of Arizant Inc., which was sold to 3M Co. (MMM - Analyst Report) in October 2010.

We are also impressed by SurModics’ financial position. At the end of the third quarter of fiscal 2012, the company had cash and investments totaling $108.2 million and no long-term debt burden. The company generated operating cash flow of $5.8 million in the third quarter of fiscal 2012, up 8.3% sequentially. We believe the strong cash position augurs well for further acquisitions in addition to investment in the current business and share repurchases.

In view of these positives, we believe that the stock is undervalued at current levels with significant scope for appreciation.

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