Is Zimmer Biomet a Buy Ahead of Earnings?

Key Points

• Zimmer could be a defensive pick in healthcare if one is worried about an impending recession.
• However, its low yield, P/E ratio, and bleak earnings outlook in the short term are its drawbacks.
• The company upwardly revised its results in the third quarter.

Zimmer Biomet Holdings NYSE: ZBH is set to report Q4'22 results on Feb 3, and there are a few things that investors should keep an eye out for.

The company is expected to have experienced continued recovery in its legacy business in Q422, driven by strong elective procedure recovery and commercial execution within the knee and hip businesses.

Its projected guidance for FY22 was revised in its results posted in Q3'22. This included an increase in its projected revenues from 0% to 1%, while adjusted diluted earnings per share (EPS) were expected to fall from $6.80 to $6.90. These updated guidance numbers were said to be reflected in its recovery from the COVID-19 pandemic. Third-quarter net sales from continuing operations of the company stood at $1.670 billion, rising 5% on a constant currency basis. 

Another factor is the completion of Zimmer's pending acquisition of Embody Inc, a privately-held medical device company, for $155 million. The deal includes Embody's complete portfolio of collagen-based bio-integrative solutions for orthopedic soft tissue injuries, including TAPESTRY bio-integrative implant.

The acquisition may boost Zimmer's top-line revenue growth but also affect its bottom-line EPS this year. The transaction is expected to be completed in February 2023 and is subject to customary closing conditions.

So let's examine the bull and bear case for investing in Zimmer to see where the company could be positioned moving forward.

The bull case

On the positive side, Wall Street is in consensus that it could represent good value for investors. It's currently fairly valued according to the MarketBeat consensus price target, showing a modest 2.41% upside. Adding to this is that the market may also think that its earnings, when delivered shortly, may come in at its posited guidance, as reflected in the short-interest ratio currently sitting at a low 1.12%.

Things are also positive on the EPS front, with analysts predicting that this ratio will grow from $6.84 to $6.94 per share in the coming year.

In terms of the company's valuation, it is also competitive when compared to its sector peers as well as the broader market. Zimmer's P/E is 95.33 at the time of writing, while the market's average P/E is 138.74. The P/Es of its sector peers are even higher at 156.64.

The final benefit is that Zimmer also has many defensive qualities as a medical device company that may afford investor protection from a recession. Medical devices are essential goods as they are used for diagnosing and treating medical conditions.

This is due to healthcare spending being considered a necessity, even during economic downturns. Furthermore, medical devices have a long lifespan, so even if the demand for them decreases during a recession, the market for these products will eventually recover.

The bear case

The opposing view of investing in Zimmer is that dividends may be an important part of a portfolio that survives an extended bear market if one eventuates. The company's dividend is one of its mean weaknesses. It presently has a yield of 0.76%, thus putting it at the bottom quartile of all dividend stocks.

Another issue is that this dividend may not be sustainable if things worsen for the economy. Its dividend payout ratio currently stands at 72.73%, just below the cut-off point generally accepted as being healthy at 75%. If the company misses its earnings estimates despite its guidance, it would easily push this into becoming very unsustainable, and right now, it's at the razor's edge.

Then there's the issue of opportunity cost. At a P/E of 95.55, it's still considered high compared to many of its peer companies, with outliers inflating the market's average. Investors could buy shares of a blue chip value stock with a stronger dividend yield if safety is concerned.

At the same time, its bleak earnings outlook leaves little in the way for growth investors to feel excited about. Although Zimmer being in a defensive industry is a nice bonus, there are companies that investors can scoop that beat it in both.

The bottom line

Zimmer stated last quarter that it should deliver stronger results when it reports results over the next few days. Investors may like that it's in a defensive industry, but there could be better options in terms of value for money, yield, and potential capital appreciation.