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Morningstar | Zimmer Biomet Makes Measured Progress in 1Q; No Change to Our FVE

Zimmer Biomet’s first-quarter results were largely consistent with our tempered expectations for the full year, and we’re leaving our valuation unchanged for now. While the firm has made substantial progress on earlier inventory issues, regulatory hurdles with the Food and Drug Administration at a legacy Biomet manufacturing facility remain an open matter. Management expects remediation efforts should wrap up by end of year. However, the FDA works on its own timeline and reinspection might not take place until 2020. Despite the operational and regulatory turbulence that has hampered Zimmer Biomet for the last two years, we remain confident the firm’s wide economic moat remains intact thanks primarily to high switching costs for practitioners and secondarily to consolidation of vendors by hospitals, which favors Zimmer Biomet’s large pool of trained surgeons.

Zimmer Biomet saw reported revenue fall 2.1% year over year, but the substantial foreign currency headwind muffled the 0.7% growth in constant currency. Though Zimmer Biomet continues to significantly lag behind Stryker (which has built up a head of steam thanks to its Mako robot), it still saw stronger growth than rival Johnson & Johnson. For example, Zimmer Biomet’s quarterly knee sales rose 0.5% in constant currency, beating the 1.9% decline in J&J knees. Importantly, underlying volume growth in Zimmer Biomet’s large joints--3.6% for knees, 4.8% for hips--supports management’s contention that it has resolved lingering inventory problems. Respectable volume gains also give us confidence that underlying demand for Zimmer Biomet implants remains healthy, despite the recent inventory disruptions.

Quarterly price erosion of 3.1% in the large joints was slightly higher than the market, though not wholly unexpected because Zimmer Biomet has yet to reap the rewards of product mix related to significant adoption of its Rosa robot.

Once we see critical mass of Rosa robots installed, we expect improved price driven by the shift toward the higher-margin devices and consumables sold for use with the robot. On the whole, we remain optimistic about Rosa, which remains in the early stages of soft launch in the U.S. According to management, the firm generated approximately 2,000 leads at a recent orthopedic conference, driven primarily by interest in the Rosa robot that received a total knee replacement indication late last year. This is in stark contrast to the 2018 conference when Zimmer Biomet received less than 100 leads. We think there are a few features of Rosa that are fairly distinctive and attractive to practitioners, including dynamic tracking, which allows the robot to move as the patient moves without any attachments to the patient.

Now, the firm must prioritize and manage those leads appropriately to convert them to robot sales. We are heartened to see practitioner interest in the technology and think it bodes well for Zimmer Biomet to present strong competition to Stryker. We’re watching conversion of leads over the next few quarters for hints of how well Zimmer Biomet has been able to execute.