So just how tough is the orthopedic market these days? Many analysts and investors seem to have battened down the hatches in anticipation of a much fiercer stand on pricing from hospitals. But with major orthopedic player Zimmer (NYSE:ZMH) publicly calling out HCA (NYSE:HCA), one of the largest hospital operators in the country, on its claim that it had earned discounts, I wonder just how successful the attempts to limit pricing will be.
And that's certainly a relevant issue for Britain's Smith & Nephew (NYSE:SNN). Although a fair bit smaller than industry heavyweights such as Stryker (NYSE:SYK) and Zimmer, and roughly similar in size to Biomet (NASDAQ:BMET), what happens in terms of pricing for the big boys ultimately matters a lot to them as well.
Moreover, Smith & Nephew is only one of two major orthopedic companies to be seeing very good growth in both the hip and knee markets. (Biomet is the other.) In the fourth quarter, for instance, total revenue rose 11%, but orthopedic revenue climbed 15% and knee and hip revenue grew 12% and 13%, respectively. That puts Smith & Nephew on top in terms of growth in the hip market and just a hair's breadth from the top in knees as well.
And assuming that pricing really doesn't fall to pieces, Smith & Nephew should continue to do all right. Newer products should make the company even more competitive in the market, including a hip system that should make its implant a more appealing alternative for younger and more active patients.
In all, I think this ongoing turbulence in the orthopedic industry will end up in compromise. Hospitals aren't going to want to push too hard, lest they alienate surgeons and open themselves up to accusations that they compromised patient care (or choice) to make a few bucks. Likewise, the big orthopedic companies will probably tacitly accept that there are limits on how much they can keep boosting their prices.
Even if that all comes true, though, I'm not too excited about owning Smith & Nephew shares. I won't bother to quibble with those who think faster-growing companies deserve a premium valuation; my issue is simply that the free cash flow numbers don't point to a compelling valuation today.
For more Foolish thoughts on the orthopedic sector:
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
