Medtech companies with portfolios dominated by more "commoditized" products such as traditional hip, knee and spine devices will find it hard to pass on rising costs to their customers, according to analysts at RBC Capital Markets. While the prediction points to headwinds for medtechs such as Stryker and Zimmer Biomet, the analysts see inflationary pressures as a "manageable risk" for the medical device industry.
The analysts looked at the impact of rising costs on medtech companies after the Consumer Price Index released by the Bureau of Labor Statistics posted a 7.5% annual gain in January. The rise topped the expectations of Wall Street and marked the biggest increase since 1982.
Medtech companies, like other industries, are impacted by the situation. As medtechs have been explaining since last year, the rising cost of materials, coupled to the linked supply chain challenges, is driving up production costs. The situation spurred the team at RBC to analyze whether medtech companies will pass the extra costs onto their customers in the form of higher prices, or keep prices steady or down and suffer margin erosion.
"Based on our conversations, we believe companies with more commoditized portfolios (e.g. traditional hips, knees, spine, CRM, stents, medical supplies) will have less pricing power and a more limited ability to pass pricing on to customers relative to those with more innovative portfolios driven by technology differentiation and/ or mix shift aided by new product launches," the analysts wrote in a Monday investor note.
Stryker and Zimmer are among the companies that may struggle to pass on cost increases to customers. On its fourth-quarter earnings call in late January, Stryker said it had unfavorable pricing of 0.8% compared to the prior year and 1.7% versus two years earlier. The medtech is forecasting another unfavorable price reduction of around 1% this year.
Preston Wells, Stryker's vice president of investor relations, warned investors last month that the overall business environment "remains uncertain as a result of the continuing COVID pandemic and we expect hospital staffing shortages, supply constraints and significant inflationary pressures caused by raw material shortages to persist throughout 2022."
Stryker has price guarantees built into its materials contracts but, with the suppliers of key electronic components unable to meet demand, it has been forced to buy on the open market. According to RBC analysts, "this is often at 40-60x the price as brokers take advantage of the situation, which is consistent with what we are hearing among other impacted companies."
Zimmer is among the other companies contending with rising costs and restrictions on its ability to up its prices. With longer-term contracts ending in the second half of 2021, Zimmer felt extra pressure toward the end of the year. The analysts expect shifts in Zimmer's product mix, such as the rise of its Rosa robot, to boost the company's pricing power down the line, but in the near term it is likely to feel the squeeze.
During last week's fourth-quarter earnings call, Zimmer CFO Suky Upadhyay said that "given the prolonged impact COVID-19 is having on our business" the company is dropping its goal of having a 30% adjusted operating profit margin exiting 2023.
Spine specialist NuVasive has historically faced pricing pressures. The RBC analysts have tracked gains in pricing power at NuVasive in recent years, but it was still down around 1% in recent quarters. Faced with rising inflation, NuVasive has so far managed the situation with cuts in other areas. However, there is a limit to how long that approach can protect margins.
"It would not surprise us if the company calls out some pressure to margins in 2022 given the underlying nature of the business where passing on cost increases to [the] customer can be challenging," the RBC analysts wrote.
NuVasive is slated to release its fourth quarter and full-year 2021 results on Feb. 23.
A mixed bag in cardio
The situation in the cardiovascular sector is more mixed. According to the analysts, Edwards Lifesciences "has better pricing power than its peers, commands a premium, and believes inflation/supply headwinds are manageable." The situation is a result of Edwards' focus on transcatheter aortic valve replacement, a market that is under-penetrated enough to ensure the company still has pricing power. TAVR prices were stable globally in the fourth quarter.
Medtronic competes with Edwards for the TAVR market, but has a more diverse portfolio. While the RBC analysts expect Medtronic to "look to pass on cost when possible," the company has "limited pricing power as it sees low-single digit price/mix declines on average on an annual basis."
Abbott Laboratories and Boston Scientific also face similar challenges. For Abbott, nutrition products offer some opportunities to pass on cost increases but its pricing power is limited in other areas. With the costs of transportation, manufacturing, commodities and more rising, Abbott expects a $500 million headwind to gross margins this year.
"As supply chains start to normalize over time, we would expect to see improving cost in some areas. For example, in commodities for Nutrition, those costs have kind of moved up and down historically over time. But currently, our kind of outlook doesn't assume any significant changes kind of versus the current dynamics that we're seeing in the market," Abbott CFO Bob Funck told investors in late January.
Boston Scientific is unable to pass price on to customers due to contracts, the analysts said, and it sees "low-single digit pressure at the gross margin line on a consistent basis." Even so, management expects full year gross margin for 2022 to improve slightly compared to the second half of 2021.
"Our assumption is that the macro environment factors of inflation and supply chain, they're present for all of '22, but they wane throughout the year. Just as you look at the global supply chain disruption, as supplies continue to get more normalized, you would expect that would have an impact on moderating prices," Boston Scientific CEO Mike Mahoney told investors earlier this month during a fourth-quarter earnings call.
CFO Dan Brennan added that Boston Scientific's longer-term goal "remains to return to pre-COVID gross margin levels of 72% plus as global supply chain disruptions and inflation lessen over time."