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We downgrade our recommendation for Conmed Corporation (CNMD - Analyst Report) to ‘Underperform’, driven by difficult hospital capital equipment spending environment and management’s lowered sales guidance outlook. Both revenues and earnings for the second quarter missed the Zacks Consensus Estimate, impacted by a decline in the company’s capital equipment offerings.

Higher sales from Arthroscopy (up 14.7%) and Endoscopic Technologies divisions (up 6.4%) were partially dampened by weak Electrosurgery (down 6.5%), Patient Care (down 6%), Powered Surgical Instruments (down 2.9%) and Endosurgery (down 4.7%) sales.

Utica, New York-based Conmed Corporation is a major medical products manufacturer, specializing in surgical instruments and devices. However, the orthopedic industry is currently susceptible to the economic softness and Conmed is no exception. The shift in hospital capital spending is bound to act as a drag on the company’s results. Revenues from 20% of Conmed’s products, which fall under the hospital capital equipment budget category, declined 10.7% in the second quarter of 2012.

Following disappointing second quarter results, the company lowered its full year sales guidance, which might weigh on the stocks’ performance. Revenues are forecast to remain between $765 million and $775 million (earlier $775 million to $785 million) for 2012. Further slowdown in Conmed’s growth rate, due to internal and external factors might affect its valuation in the marketplace. In the end, failure to sustain the growth rate may lead to compression of Conmed’s multiple.

Furthermore, manufacturing difficulties and slower product adoption, significant competition and pricing pressure remain additional challenges. Conmed operates in a highly-competitive orthopedic surgery market against much larger, more technically-competent companies, such as Covidien plc. (COV - Analyst Report), Smith & Nephew plc. (SNN - Snapshot Report) and Stryker Corporation (SYK - Analyst Report).

However, despite declining capital equipment sales, Conmed is experiencing healthy growth for its single-use disposable products. The company derives roughly 80% of its total revenues from single-use disposable products, which remain the mainstay of its business. Additionally, it is benefiting from the increasing trend of using minimally invasive techniques as a large percentage of the company’s products are designed for these procedures.

In addition, Conmed’s focus on portfolio expansion is expected to yield positive results. Its recent pact with Musculoskeletal Research Foundation (MTF) provides opportunities for incremental revenues and will be accretive to its earnings this year. Moreover, the acquisition of Viking Systems is expected to be a material upside in the future but the integration issue remains a concern.

We believe that the company will continue to face weak capital purchasing environment in the near term. Our ‘Underperform’ recommendation on the stock coincides with our short-term Zacks #4 Rank (Sell rating).

 

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