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Zimmer Stays Neutral

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We have reaffirmed our Neutral recommendation on Zimmer Holdings with a target price of $69.00.

Zimmer reported third quarter adjusted earnings per share (EPS) of $1.15. The results surpassed the Zacks Consensus Estimate by a couple of cents and were ahead of the year-ago earnings of $1.04. Revenues were $1.026 billion, up 2.5% at CER and almost in line with the Zacks Consensus Estimate. During the quarter, currency was a major headwind and reduced revenues by 3.1%.

During the reported quarter, increased volume and changes in product mix contributed 5 percentage points of year-over-year sales growth, which is 2 percentage points better than the year-ago quarter and 1 percentage point better sequentially. We are impressed to note that during the quarter, procedure volumes in the broader musculoskeletal market remained stable, 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 U.S., offset by modest weakness outside the U.S. We expect the situation to improve with procedural deferrals diminishing with time.

Zimmer should also benefit from favorable long-term trends that point toward 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 ongoing shift in demand to premium products, such as Prolongand Vivacit-EHighly Crosslinked Polyethylene, Trabecular MetalTM Technology products, high-flex knees, porous hip stems and the introduction of patient specific devices, is expected to remain favorable to sales growth.

Over the recent past, Zimmer has been working to strengthen its foothold in the emerging markets that provide long-term growth opportunities. 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. This, according to the company, had a greater-than-expected impact on pricing and will continue to do so for the remainder of the year.  Zimmer faces tough competition from players such asStryker (SYK - Free Report) and Smith & Nephew (SNN - Free Report) , among others.

Our recommendation is backed by a Zacks #2 Rank (Buy) in the short term.

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