Biomet: A Bet on Bones

08/12/2005 12:00 am EST


Michael Ozanian

Senior Editor, Forbes Earnings Quality Report

Like all other newsletters published under the its banner, the Forbes Earnings Quality Report, is itself, top quality. Editor Michael Ozanian looks beneath "reported profits" to assess the true quality of those earnings. Here, he looks at Biomet, a play on orthopedics.

"Biomet (BMET NASDAQ) designs and makes products used primarily by orthopedic surgeons in both surgical and non-surgical therapies, such as reconstructive and trauma devices, electrical bone growth stimulators, support devices, and operating room supplies. About one-third of its $1.9 billion in annual sales comes from outside the US. The stock is down 15% this year compared with a flat NASDAQ, due to stiff competition in the reconstructive hip and electrical stimulation markets, which has hampered earnings growth. For the fiscal year ending May 2005 BMET reported earnings per share of $1.38, 9% higher than the previous year. It was the first time since 1999 that the company posted earnings growth below 12%.

"Another cloud over the stock is that BMET has received a Department of Justice subpoena requesting documents related to consulting and professional service agreements with orthopedic surgeons (similar inquiries have been directed to other orthopedics companies).Wall Street expects the company to get back on the fast-growth track with the help of new spinal products like the Altius cervical rod and the Polaris Syndergy thoracolumbar system, as well as successful new reconstructive knee products. The average earnings per share estimate for this widely followed stock (24 analysts track the company for Thomson First Call) for the current year is $1.79, with a low of $1.74 and a high of $1.84.The projected 5-year annual average earnings growth rate is 16%.

"In our view, here is a company that has consistently minted huge amounts of money by rebuilding the human body. Biomet has become one of the leaders in its industry because its products possess excellent long-term clinical results, supporting the efficacy of the company's strong science and engineering focus. In addition, the company has a tradition of superior customer responsiveness. The company's long-term track record speaks of incredibly consistent performance: During the past 15 years, sales, operating income and earnings have increased 18%, 21% and 20%, respectively, and its opportunities for continued growth are excellent.

"The company's products are used primarily by people between the ages of 55 and 75, an age group that is expected to grow more than 37% over the next ten years, according to the US Census Bureau. Despite its single digit earnings growth last year, I expect the company to hit the high end of this year's earnings estimates because of its good earnings quality. The company throws off a lot of free cash flow (cash generated by the business less money it spends on plant and equipment). For the 12 months ending in February, free cash flow per share was $1.08, more than twice the free cash flow it yielded three years ago.

"Management will use that cash to bolster shareholder returns through product innovation and share buybacks. For example, in March the board of directors authorized the buyback of an additional $100 million worth of stock, supplementing the $41.8 million remaining from the $100 million authorization of July, 2004. And in July the company declared a cash dividend of 25 cents. With no debt and $177 million of cash, BMET sports a rock-solid balance sheet. Another reason the stock is worth accumulating: The recent dip in BMET's shares has left it trading for just 21 times this year's expected earnings, a much lower multiple than its rivals."

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