Zimmer Holdings Remains Neutral

We have reaffirmed our Neutral recommendation on Zimmer Holdings ( ZMH - Analyst Report ) with a target price of $67.00.

Zimmer’s second-quarter adjusted earnings of $1.34 per share were ahead of the Zacks Consensus Estimate by a couple of cents while revenues lagged the consensus estimate with a dip of 1.1%. During the quarter, currency was a major dampener that reduced revenues by 2.9%.

During the reported quarter, increased volume and changes in product mix contributed 4 percentage points of year-over-year sales growth, which is 1 percentage point better than the year-ago quarter, but 1 percentage point worse sequentially. We are impressed to note that procedure volumes in the broader musculoskeletal market remained stable in the quarter, in line with the company’s expectations. Moreover, volume trends in the reconstructive market remained relatively stable through the second quarter with some improvement in the US, offset by modest weakness outside the US. We expect the situation to improve with procedural deferrals diminishing with time.

Zimmer should also benefit from favorable long-term trends that point towards sustained growth, driven by an aging global population, obesity, wear and tear of joints from more active lifestyles, growth in emerging markets, new material technologies, advances in surgical techniques and proven clinical benefits of joint replacement procedures. Moreover, the shift in demand to premium products, such as the Prolong Highly Crosslinked Polyethylene, Trabecular Metal Technology products, hip stems with Kinectiv Technology, high-flex knees, porous hip stems and the introduction of patient specific devices, is expected to positively affect sales growth.

Over the recent past, Zimmer has been working to strengthen its foothold in emerging markets that provide long-term opportunities for growth. The company’s strategic investments in these regions over the past several quarters to improve operational and sales performance are yielding results. During the reported quarter, the company acquired Exopro, a manufacturer of differentiated dental implant products for the Brazilian market.

Pricing, however, continues to remain a major headwind for Zimmer. The company experienced (2.1%) of pricing pressure in the reported quarter, consistent with its guidance. Based on recent trends, pricing for 2012 is likely to remain at (2%). We remain concerned about the pricing scenario as it will be affected by cost containment efforts by governmental healthcare, local hospitals and health systems. In addition, effective April 2012, a biennial price adjustment went into effect in Japan which will continue to impact pricing for the remainder of the year, the effect of which was greater than expected. The company faces tough competition from players such as Stryker ( SYK - Analyst Report ) and Smith & Nephew ( SNN - Snapshot Report ) , among others.

Our recommendation is backed by a Zacks #3 Rank (Hold) in the short term.