SurModics Reverts to Neutral

We are reverting to a Neutral recommendation on SurModics Inc. (SRDX - Analyst Report) from Outperform as we believe that the stock is fairly valued at current levels. Our target price is $19.00. The stock carries a Zacks #3 Rank (Hold rating) in the short run.

In November 2012, SurModics came out with decent numbers for the fourth quarter of fiscal 2012 (ended September 30, 2012). The company’s fourth quarter fiscal 2012 adjusted earnings of 19 cents per share beat the Zacks Consensus Estimate by 2 cents. Adjusted revenues climbed 12.3% to $13.8 million in the final quarter of fiscal 2012. Strong sales of vitro diagnostics offerings and hydrophilic coatings boosted revenues.

We note that SurModics has taken a number of steps to improve efficiency following its disappointing performance in fiscal 2010. The company trimmed its work-force and made certain changes to its organizational structure to improve efficiencies.

Moreover, following the disappointing performance in fiscal 2010, SurModics revamped its board of directors and also brought about a change at its helm, with the appointment of a new CEO, Gary R. Maharaj. We note that Maharaj is the former President and CEO of Arizant Inc., which was sold to 3M Company (MMM - Analyst Report) in October 2010. We are positive on the sale of SurModics’ Pharmaceuticals unit in 2011 as this has allowed the company to focus on its core businesses.

However, since royalties are a major source of revenues at SurModics, any royalty related setback will affect the top line. For example, Johnson & Johnson’s (JNJ - Analyst Report) decision to stop manufacturing Cypher and Cypher Select Plus sirolimus-eluting coronary stents, from which SurModics earned royalties, affected SurModics’ top line. Setbacks of a similar nature will negatively impact SurModics’ stock price.

While encouraged by the steps taken by the company to revive itself, we see limited upside potential for the stock from current levels.