Sector Watch: Joint replacement
Like a fine wine, life gets better with age, but sometimes parts need replacing to keep your engine going. With the inevitable onset of age permeating the baby boomer generation, boomers are getting a new lease on life—in the form of hip and knee replacements, the demand for which is expected to steadily increase.
Last year, nearly 8,000 people were turning 60 each day, amounting to 330 every hour, and their ranks will only get larger, according to the U.S. Census Bureau. On a global scale, industry analysts predict 8% annual growth in the $4.6 billion worldwide knee replacement market and 6% annual growth in the $5.2 billion hip replacement market.
The rise in growth in the joint replacement market is already benefiting Symmetry Medical Inc. (NYSE: SMA) and Orthofix International (Nasdaq: OFIX), two small caps that deal in equipment for orthopedic applications.
Warsaw, Ind.-based Symmetry Medical designs, develops and produces implants and related instruments for orthopedic device manufacturers. Its implants are used in hips, knees and other joints. The company also provides trauma implant systems used to repair damaged bones and spinal implants for the treatment of degenerative spine disease. (Spinal implants represent a $5.3 billion market that is growing 11% annually.) Symmetry Medical also manufactures surgical instruments, orthopedic cases for storing and transporting orthopedic devices, endoscopy cases for endoscope sterilization and dental cases for dental implants and instruments.
The company served 863 customers in 2006, gained 111 new customers last year and counts among its clients leading implant system manufacturers such as Zimmer, Stryker, Wright, Biomet, the Deputy division of Johnson and Johnson, and Smith and Nephew. Approximately 60% of Symmetry’s sales are made in the United States.
An aggressive acquirer, Symmetry Medical boosted first-half 2007 revenues $6.5 million through three acquisitions and has subsequently completed two additional acquisitions. While six-month 2007 revenues were up only 2% year-over-year to $137 million due to soft market conditions, the company secured several larger orders in July that have caused it to increase its full-year 2007 revenue guidance by 11% to $280 million.
Flooding problems at a U.K. manufacturing facility resulted in one-time charges that caused six-month 2007 per-share earnings to fall 50% year-over-year to $0.23 from $0.46. Symmetry is in the process of expanding its overseas manufacturing to take advantage of low costs abroad and enhance its global presence.
Symmetry Medical’s long-term performance goals target 12% to15% annual sales growth and 18%-plus annual earnings growth. Analysts predict this company will produce 45% sales growth next year and longer-term growth averaging 15% annually. Because of the disappointing June quarter results and the announcement it may need to restate its U.K. financials, Symmetry’s share price has dropped to $16 from $18 earlier this year. Shares of Symmetry (SMA) closed at $17.14 on Tuesday. Over the last 52 weeks, shares have ranged between $12.62 and $18.62. My $22 price target for Symmetry is nearly 40% above the current price.
Orthofix International also designs, manufactures and distributes medical equipment for orthopedic applications. Its offerings include spine implant products, non-invasion stimulation products for spine fusion and external fixation devices for fracture repair.
Orthofix distributes products to the spine, orthopedics, sports medicine and vascular markets but derives 40% of sales from spinal implant products. These products address the neck and back problems that people develop as they age, relieving pain and restoring stability in the spine.
The company is based in the Netherlands and sells its products in the United States, Europe and South America. Sales are made through Orthofix sales representatives, its BREG and Blackstone Medical subsidiaries, and via partnerships with leading orthopedic product companies such as Kendall Healthcare. Orthofix also has R&D partnerships with Rutgers, the Cleveland Clinic and the National Osteoporosis Institute.
During the first six months of 2007, Orthofix’s revenues grew 45% year-over-year to $240.4 million, fueled by acquisition and organic growth. While net income was lower at $13.5 million, or $0.80 per share, for the first six months of 2007, versus $20.9 million, or $1.30 per share, in the same period last year, the decline was mainly due to higher non-cash stock compensation. Earnings were also impacted by acquisition-related interest expense and a weaker U.S. dollar, which increases Orthofix’s costs since its products are manufactured in Europe and sold in the United States. Orthofix forecasts 2007 per-share earnings at $1.86 to $1.96, approximately twice 2006 earnings of $0.57. Analysts believe this company will produce 33% growth next year and 23% annual growth over the next five years. Trading at $53.45 on Tuesday, OFIX was not far from its 52-week high of $54. The stock’s 52-week low is $42.01. My $65 target for Orthofix is 25% above the current share price.
