Are hospitals finally going to start fighting back against price increases for orthopedic implants? That's still the $64,000 question for the industry as a whole, and a concern that has pushed Biomet's (NASDAQ:BMET) stock down about a quarter from its high. I really don't think results for the company's first fiscal quarter are going to clarify matters all that much, as there was some good news and some news that wasn't so good.
Sales climbed about 10% (excluding foreign exchange), but operating margins eased off a bit. As such, operating income (after adjusting for certain year-ago charges) climbed 8% and in turn fueled a 10% increase (again, after adjustments) in net income. While the company said it was comfortable with estimates for the second quarter, it didn't say much of anything about the full year. That's good and bad -- good in the sense that it's not using the Katrina excuse; bad in the sense that it won't dispel the worries and rumors about price erosion.
There was also good news and bad news in the makeup of the quarter's performance. Sales of reconstruction products, particularly hips and knees, were solid. Other categories like fixation and spinal care were pretty weak. So while I'm more than willing to give props to Biomet for its hip and knee business (and its technological progress therein), you can't help but be a bit worried about what happens if/when growth in hips and knees slows down. It's largely the same problem that faces Zimmer (NYSE:ZMH) -- both of these companies are much more dependent upon hips and knees than some others, such as Stryker (NYSE:SYK) or Johnson &Johnson (NYSE:JNJ).
Now, that said, Biomet's management is not echoing the alarms we've seen elsewhere about pricing in the sector. Some believe that Biomet's policy of emphasizing marketing directly to surgeons could be a risk in an environment where hospital administrators are looking to take more control. Biomet counters by suggesting that some surgeons have left their hospitals and performed orthopedic surgeries elsewhere in response. Likewise, management apparently believes that the impact of gain sharing and price resistance might be less than what we've heard.
I'll take a middle-road stance for now. I do believe that orthopedic companies are going to see a lot more resistance to price increases than they have in the past. But I also believe that companies can respond by shifting product mixes toward more profitable products. Further, the larger companies might be able to mobilize their size for better operating leverage in the new environment.
Whatever the case turns out to be, Biomet is probably a bit riskier than average. It is not one of the largest players, but it is heavily dependent upon those product categories where pricing and reimbursement may be under the most pressure. But I still like the long-term fundamentals of the business, so patient investors shouldn't necessarily be scared off.
More reconstructive takes:
Fool contributor Stephen Simpson owns shares of Johnson & Johnson. The Fool has an ironclad disclosure policy.
