Over the last few weeks, I’ve been turning my attention more and more to companies in the Health Care sector, simply because as COVID-19 quickly turned from a distant, overseas problem to a global crisis that has now impacted the world on multiple levels, health care is among the few areas of the economy that will continue to remain an economic constant. The market’s main focus and attention right now, of course is on companies that are working to help address COVID-19 issues on multiple medical fronts, from testing to supply, treatment and ultimately vaccination. That means there are a number of industries in the sector that are actually pretty interesting right now, which offers several different useful avenues to look for useful investing candidates.
It’s pretty easy to say that even when economic times are difficult, healthcare is something people will continue to to need, which is why the sector historically has shown recessionary resilience. One of the things that I think you have to be a little bit careful about, however, is lumping all of the companies in every single industry into that same boat. The truth is that the longer economic pressures, like unemployment, declining incomes, and drastically declining consumer trends and commodity values (think crude oil, which is cratering right now amid drastically shorted demand because of COVID-19) last, the more discriminatory people become about what goods, products and services they really need versus the ones they can do without. In healthcare, that means that patients will start to differentiate between critical and elective healthcare needs. COVID-19, cancer or other long-term disease treatments, emergency care – those are things that will always take precedence over treatments and procedures that can be delayed in one form or another.
There are several examples of what I mean. Dental implants are important, and certainly useful; but if a patient will have to choose between getting a dental implant or being able to pay for basic needs like rent, food, clothing or transportation, you can bet the dental implant will get pushed down the priority list. Orthopedics are another example; you might need a procedure for your hips, knees, feet or shoulder to alleviate pain in that part of the body, but until that kind of discomfort is too acute to be tolerated any longer, most people tend to delay them as long as possible. As an investor, that means that companies that provide products and solutions for this segment of the healthcare market, like Zimmer Biomet Holdings Inc. (ZBH) are at a different end of the risk/reward spectrum than some of their peers.
Over the last month, ZBH has followed the rally of most healthcare stocks higher, rallying abotu 33% off of lows the stock hadn’t seen since the latter part of 2013. Despite the impressive rally since the end of March, the stock remains more than -25% below the all-time high it reached in mid-February at around $160. Does the stock’s fundamental profile support the idea that the stock could still represent a useful value? Let’s dive in to find out.
Fundamental and Value Profile
Zimmer Biomet Holdings, Inc. is engaged in designing, manufacturing and marketing of orthopedic reconstructive products; sports medicine, biologics, extremities and trauma products; office-based technologies; spine, craniomaxillofacial and thoracic products; dental implants, and related surgical products. The Company’s products and solutions help treat patients suffering from disorders of, or injuries to, bones, joints or supporting soft tissues. The Company manages its operations through three geographic operating segments: the Americas, consisting principally of the United States and other North, Central and South American markets; EMEA, consisting principally of Europe and the Middle East and African markets, and Asia Pacific, consisting primarily of Japan and other Asian and Pacific markets. The Company’s product category segments include Americas Spine, Office Based Technologies, Craniomaxillofacial and Thoracic (CMF), and Dental. ZBH has a current market cap of $24.4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings improved modestly, by about over 5.5%, while sales increased about 2.64%. In the last quarter, earnings improved by almost 30% while sales were 12.3% higher. The company’s margin profile is healthy; over the last twelve months Net Income was 14.17% of Revenues, and strengthened slightly to 15.08% in the last quarter.
Free Cash Flow: ZBH has free cash flow of a little over $1.06 billion over the last twelve months. This number has declined from December of 2018, when it was about $1.3 billion; but it also marks an improvement from the last quarter, and translates to a Free Cash Flow Yield of about 4.34%.
Debt to Equity: the company’s debt to equity ratio is .54, a conservative number that generally indicates a conservative approach to leverage. Long-term debt was $6.7 billion in the last quarter versus about $618 million in cash and liquid assets. Given their healthy operating profile, servicing their debt isn’t currently a problem; however, it should be noted that the last available quarter’s numbers were the end of 2019, which means that the impact of COVD-19, negative, positive, or otherwise has yet to be indicated in any significant way. A long-term drop in the company’s operating profile could raise concerns about their ability to pay down debt.
Dividend: ZBH pays an annual dividend of $.96 per share, which translates to an annual yield of 0.81% at the stock’s current price. While the dividend itself isn’t remarkable, it is noteworthy that company pays a dividend in an industry where the majority of stocks do not; I also think that is useful to note that the company’s dividend payout ratio is less than 25% of current earnings, which is very conservative.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $134 per share. That means that despite the stock’s increase over the last month, it remains meaningfully, if not compellingly undervalued, with about 15% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the stock’s price movement over the past year. The red diagonal line marks ZBH’s downward trend beginning in mid-February, at a peak around $160 per share to a low point in March around $75. From that point, the stock has staged a sizable rally, with big bullish momentum driving the stock to its current value around $116. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The 38.2% retracement line, sitting at around $107.50 provides the stock’s current level of support, with immediate resistance between $118 and $121, using the 50% retracement line along with previous pivots in the summer of 2019 as a reference point. If the stock can break above $121, it should find enough momentum to drive to about $128 in the near term; however if the stock turns back down off of its current resistance levels, it has about $10 in downside potential right now to the 38.2% retracement line.
Near-term Keys: ZBH’s valuation metrics are interesting right now, and along with the stock’s recent rally and general fundamental strength it might be tempting to think about taking a position in the stock at its current price. I think that might be a little aggressive right now, given that all of the fundamental information that is available applies only to the end of 2019; there has been no useful guidance by the company since the last earnings report, and even the next earnings report is likely to reflect only a portion of the actual impact of the current pandemic on its operations. The sum total of that impact may extend for two to three quarters, so it will be useful to see what commentary management chooses to offer in its next report, which is due in the second week of May. I think the most practical way to use ZBH is with short-term trades right now. If the stock breaks above $121, take it as a good signal to buy the stock or work with call options, with $128 acting as a useful exit point for a momentum-based trade; on the other hand, if the stock hits current resistance between $118 and $121 and turns back lower, you might consider a swing-based bearish trade by shorting the stock or working with put options, using $107.50 as a bearish profit target.