We are downgrading SurModics Inc. (SRDX) to Underperform from Neutral following its disappointing showing in the final quarter of fiscal 2010. Our target price is $8.50.
The company missed Zacks Consensus Estimates both in terms of revenues and earnings. The below par showing was attributable to the sharp decline in revenues across all segments.
(Read our full coverage on the earnings results: SurModics Disappoints in Q4 )
Following the lackluster showing, Surmodics decided to trim its workforce and implement an organizational restructuring in order to serve its customers better. The company trimmed its work-force by 13% and made certain changes to its organizational structure. Following the latest restructuring, the company now operates through three business units: Medical Device, Pharmaceuticals and In Vitro Diagnostics.
The disappointing showing in the fourth quarter of fiscal 2010 has caused us to reduce our estimates for fiscal 2011 revenues as well as earnings. We have lowered our fiscal 2011 revenue estimates to $59 million from $74 million.
The reduced revenue estimates are based on expectations of lower revenues from the Medical Device and Pharmaceutical units coupled with modest growth from the In Vitro Diagnostics operation. Earnings estimates for fiscal 2011 have been reduced by $0.58 to $0.05 per share.
The continuous pressure on the cardiovascular segment (now a part of the Medical Device unit) due to the reduced sales of Cypher stent — which is marketed by Johnson & Johnson’s (JNJ) Cordis division — is another concern.SurModics earned about 58% of its revenues from the erstwhile cardiovascular segment in the most recent quarter. The company derives a substantial majority of its drug delivery revenue (recorded under this segment) from sales of the Cypher stent.
According to Johnson & Johnson, worldwide sales of Cypher during the most recent quarter were $136 million, down 36% year over year and 19% sequentially. Cypher faces continuing competition from Boston Scientific Corporation’s (BSX) Taxus drug-eluting stent and stents manufactured by Medtronic (MDT), Abbott (ABT) and others.
Further, drug-eluting stent sales have been adversely affected by recent concerns over drug coated stent safety. Therefore, we expect that future drug delivery royalty and reagent sales revenue will be volatile because of lower Cypher sales, as a result of ongoing and potential competition and overall market contraction. This scenario has the potential to hamper revenues at Surmodics in the coming quarters.
Moreover, the termination of the collaborative research and license agreement with Merck (MRK) for the development and commercialization of the I-vation sustained drug delivery system for the treatment of serious retinal diseases is a dampener. We remain concerned about the company’s current partnership programs as the termination of any partnership agreements will hit the company’s top-line.
These headwinds lead us to believe that the risk/reward profile is tilted towards risk at SurModics. Even though SurModics has trimmed its workforce and implemented an organizational restructuring in order to serve its customers better, we believe that unless the move works in the desired direction there is no reason for investors to own the stock at current levels. Consequently, we downgrade the stock to Underperform.
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