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Is This Huge Market Slowing Down?

Waiting for a recovery in the orthopedic market isn't exactly waiting for Godot, but it has been frustrating all the same. Between modest (but steady) price pressure, lower patient volumes, and more assertive hospital customers, major ortho companies like Zimmer (NYSE: ZMH  ) , Stryker (NYSE: SYK  ) , and Johnson & Johnson (NYSE: JNJ  ) have had their work cut out to generate better results from what has historically been one of the largest medical device markets, and a profitable one at that.

As the second quarter earnings cycle revs up, Biomet has started things off with its fiscal fourth quarter report. Although there's nothing in the report that should worry Zimmer investors (Zimmer is in the process of trying to get regulatory approvals for its acquisition of Biomet), there is likewise not a lot to really encourage investors hoping for a major return to growth in the quarter.

Major joints mostly steady as she goes
Biomet reports on an off-calendar basis, which compromises comparability, and there are often company-specific factors (new product launches or announced launches on the way, etc.) that can likewise impair comparisons. Nevertheless, Biomet offers a few general takeaways.

Biomet reported roughly 6% organic growth for the fiscal fourth quarter (ended May 31, 2014), with constant currency growth of 4.6% in knees and 3.2% in hips and U.S. growth in those categories of 2.2% and 0.4%, respectively.

That's a marked deceleration from 6% yoy growth in hips in the first quarter, though that result was anomalous for both Biomet and the industry. Stryker has been quite strong here of late, growing 4% to 5% above the industry in 2013 before a slowdown to "market+3%" in the first quarter. Johnson & Johnson had been outgrowing the global hip market before Q1, while Zimmer and Smith & Nephew (NYSE: SNN  ) had been lagging. Biomet's result is a little disappointing and may well be pointing to continued sluggishness.

On the knee side, Biomet has been the market leader in growth terms for more than a year and will likely remain so, though Zimmer has been picking up momentum. Stryker's performance has been relatively feeble, while Johnson & Johnson has been matching the market as Smith & Nephew has lagged.

Spine, extremities, and trauma more idiosyncratic
Biomet's position in spine, trauma, and extremities make its results less predictive or indicative for the industry than in major joints. The 5% growth in sports medicine, extremities and trauma wasn't bad, but it seems likely that smaller, more extremities-focused companies will outperform. On the spine side, the company's results were boosted by an acquisition but it does appear that the overall spine market is getting healthier – good news for NuVasive, most likely.

A second request isn't too surprising
Zimmer and Biomet reported that they had received a second request from the FTC regarding their proposed merger. Given the size of the combined companies and the complexities of the merger, such a request is not very surprising.

As a reminder, the combined companies will have significant (and market-leading) share in both knees and hips. Given the past precedents of Medtronic in spine and Johnson & Johnson in spine and trauma, there likely won't be much push-back in major joints (and if Stryker gains more share in partial knee with MAKO, that won't hurt the Biomet-Zimmer case). Areas like shoulder could be more problematic, though, as I've seen estimated of their combined share ranging from 35% to 50%-at the high end, regulators may well push for divestitures.

The bottom line
Major orthopedic companies like Zimmer, Johnson & Johnson, and Stryker seem more or less resigned to an "it is what it is" level of low-to-mid single-digit market growth, with companies periodically grabbing or losing momentum on the basis of product launches, recalls, and so on. The spine, trauma, and extremities markets offer more upside, and that likely motivated Stryker's recent decision to acquire Small Bone Innovations. Looking at the quarter to come, it doesn't seem that the market is changing all that quickly and companies will have to continue to innovate or diversify to augment the sluggish growth in major joint reconstruction.

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Stephen D.

I'm an ex-Wall Street sell-side and buy-side analyst who has spent most of the last 10 years writing on a wide range of industries and investment ideas.

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