Will Baby Boomers Pull Orthopedics Out of Recession?

We’re getting close to the bottom of the orthopedic market recession and demographics are in favor of healthcare. That’s what the CEO’s of two of the largest companies in orthopedics say.

Stephen MacMilla
Stryker CorporationStephen MacMillan and Bill Weldon, the respective heads of Stryker Corporation and Johnson & Johnson, Inc. (parent of DePuy Orthopaedics, Inc.), recently spoke to analysts and investors about the state of their companies, healthcare and orthopedics in general and their companies in particular.

“Demographics Favor Healthcare”

Their messages were the same. Procedure volumes will not increase until Americans get their jobs back with insurance coverage and those with jobs decide that getting rid of the pain in their joints is more important than taking time off to recover from surgery.

MacMillan and Weldon also say that the progression of orthopedic diseases means untreated pain gets worse and patients who have been putting off the “discretionary” procedures will eventually have to come and get treatment. And then there are those pleasure-seeking baby boomers who want to remain active in their old age and will serve as a huge tailwind for the orthopedic industry.

“Demographics are in favor of healthcare, ” Weldon told analysts during a quarterly conference call on January 24.

Slow Growth

The most recent fourth quarter results for the two companies support their point that procedure volume growth rates have declined due to the recession. Stryker’s Recon business was up by only 1.3% and it was Stryker’s fast growing Medical Surgical business that pulled overall sales up to a reported $2.2 billion, +11%. DePuy’s revenue of $1.45 billion was also flat. DePuy’s results also do not yet include quarterly results from Synthes. The two companies expect to complete a merger this year and make the combination the biggest orthopedic company in the world. Synthes will report fourth quarter results in February. 

Keeping in step with the market’s low procedure volume growth, both companies reported that hips sales increase by only 1%, while knees fell 2% for Stryker and 3% at DePuy.

But back to the big picture.

According to Weldon, there are three major forces that are shaping the healthcare environment:

• 
  

  Macroeconomic conditions

Macroeconomic Conditions

Weldon said macroeconomic conditions have been incredibly challenging the last several years, but opportunities remain. “Slowing economic growth, the uncertainty in financial markets, high unemployment and pressure in healthcare costs have all contributed to constraints on healthcare spending, and the volatility of currency exchange rates continues to be an issue.”

Bill Weldon/Johnson & JohnsonHowever, he said these economic dynamics are balanced by positive demographic trends creating demand. “Populations in the developed world are aging rapidly and we consume more healthcare as we grow older. In fact, those over the age of 65 consume an average of 7x more healthcare per year than those under that age.”

Global expansion and growth, even at less explosive rates than a few years ago, also leads to growing demand for healthcare, especially in emerging markets where access has been its historically low. Weldon says JNJ’s investments continue to be in line with these market opportunities.

Government Payers and Regulators

“Government payers are requiring more cost-effective solutions…and that impacts the pricing of healthcare products and services.” He says the company recognizes these priorities and is making investments in new and productive areas such as personalized medicine and companion diagnostics.

Weldon also pointed to a regulatory environment that has become “much more intense” in its scrutiny of new products. Weldon says he supports strong regulatory environments that ensure patient safety, while also ensuring that the fast and efficient approval of potentially life-saving medicines and treatments.

Industry Trends

Weldon said the company has always looked to complement organic development with acquisitions and collaborations that help gain new capabilities or provide access to technology, products and compounds that can accelerate products to the market. He also noted that over the past five years, the global healthcare market has had compounded annual growth of nearly 7%, and it should continue to see strong mid-single-digit growth over the next five years. And growth in the emerging markets will be double digits as those economies continue expanding.”

Utilization Trends – “Getting Close to the Bottom of the Trough”

In addressing a question from analysts about utilization trends, Weldon said the big area is in elective surgery where the industry is seeing the slope of the line and the decline [of procedures] to starting to smooth out “a little bit.”

“The last time I looked at [procedure volume], it was about a 0.5% drop in elective surgery. So we think we’re getting close to the bottom of the trough…. You can only put these procedures off for so long. And there’s going to be a bolus of people that will come back in the market over time. Now I don’t know if it’s going to be in 2012 or 2013, but I don’t think the market is going to decline as precipitously as it had previously.”

Weldon added that there is a huge resource. “By that, I’m talking about resources that the government is willing to spend for patients coming into the market. So I think when you look at it, that there’s an opportunity.”

Stryker’s Cash Machine

MacMillan said looking back on the company’s 2011 financial results he was encouraged while remaining cognizant of the current economic environment.

Sales

($ in millions)

% Change 

Total Reported Sales

$2, 215

11.0%

     Reconstructive

$981

1.3%

          Hips

$314

1.0%

          Knees

$341

down 2%

          Trauma/Extremities

$253.00

9.1%

     Med Surg

$857

11.2%

     Neurotech/Spine

$377

47.3%

     Spine

$178.0

6.0%

Source: Stryker Corporation                                   

“We completed 2011 with over $8.3 billion in sales, up 11% on a reported basis and reflecting mid-single digit organic growth, augmented by the benefit from a series of key strategic acquisitions as well as a currency tailwind.”

“We head into 2012 with strong momentum, a compelling lineup of new products and a high degree of conviction regarding our ability to continue to deliver strong growth in these businesses.”

Not to mention a boatload of cash. “We enter 2012 with a net cash position of over $1.6 billion, so our balance sheet remains an important competitive strength for 2012 and beyond.

Reconstructive Slowdown

Although Stryker’s Reconstructive implant growth slowed sequentially, MacMillan said he was encouraged by the ramp up of the company’s MDM large head hip offering as well as the traction that their customized cutting guides are now seeing within knees.

“While we conservatively assume no improvement in elective procedure trends in 2012, we believe that share gains in hips and knees are achievable. And if the economic environment and/or the degenerative nature of osteoarthritis results in a stronger rebounding of implant procedures, we are well positioned to capitalize on the volumes.”

The company is committed to delivering organic sales growth at a minimum of 2% to 5% in 2012, which atop the contribution from acquisitions, positions the company to post a rate of constant currency revenue growth in the 3.5% to 6.5% range.

DePuy – Waiting and Recovering

The story for DePuy is all about waiting for Synthes and recovering from the ASR metal-on-metal hip recall and lawsuit settlements. The company still expects to close on the Synthes acquisition later this year and disclosed that is has set aside over $3 billion to deal with various recalls and settlements.

DePuy reported that sales grew 0.3% to $1.453 billion for the fourth quarter of 2011. Strong sales in sports medicine were partially offset by lower sales for knee and spine products. Results, according to the company, continue to be affected by low-single-digit price erosion, partially offset by positive mix.

Sales

($ in millions)

% Change 

Total Reported Sales

$1, 453

0%

          Knees

$355

down 3%

          Hips

$295

1%

          Spine

$236

down 2%

     Bone Cement/Codman

$249

down 1%

     Sports Medicine/Mitek

$167

8%

     Trauma

$81

5%

Source: Larry Biegelsen, Wells Fargo Securities

Reported hip sales were up 1%, driven by 3% growth outside the U.S. In the U.S., hips were essentially flat. Globally, sales of knee implants declined 3%, with U.S. shipments declining 5% due to increased competition and a softer market. Sales outside U.S. were flat.

In management’s estimation, overall demand for orthopedic products declined modestly in the third quarter with U.S. showing the most decline (down 3%) and the OUS market slipping 1%. That softness continued into the fourth quarter. Spine was down 3%, with the U.S. down 7%, primarily due to continued pressure on price. Sales outside the U.S. actually rose 4%.

The Cost of Metal-on-Metal

In setting aside more cash for product liability costs primarily related to the DePuy ASR Hip recall, JNJ’s executives said they have recently completed an analysis of new information, including recently updated revision rates for the recalled products, and have updated estimates with respect to potential costs associated with the recall.

JNJ’s CFO Dominic Caruso told analysts that that over the past two years the company’s hip recall program costs has cost about $800 million.

Medical Device and Diagnostics

Outside the U.S. sales of JNJ’s MD&D (medical device and diagnostics) products showed strong double-digit growth in 2011. Management also announced in its call with analysts that they had increased investments in emerging markets with recently opened innovation centers in India and China, while continuing to support dozens of training institutes around the world.

“With these actions and others, MD&D has been able to sustain #1 or #2 leadership positions in 80% of our key platforms, while growing or maintaining share in the majority of these markets.”

Weldon reported that to better serve a market that has been undergoing dramatic change, the MD&D segment began reorganizing into three more integrated and agile businesses at the end of November. The business groups consists of the Global Surgery Group, the Global Medical Solutions Group, and the Global Orthopedics Group.

Preparing for 2012

Both leaders made it clear that while top line growth is not expected to recover to pre-Great Recession levels just yet, they do see the potential for a wave of new patients who are making appointments to treat their orthopedic unmeet needs. In the meantime, both management teams are reassuring investors that pre-Great Recession earnings growth rates are still possible by throwing their substantial cash into high growth areas and continually reorganizing and improving operating efficiencies.

In short, they think they see a rise in unit demand and are preparing for it.