TOM GALVIN
SENIOR PORTFOLIO MANAGER
EXCELSIOR LARGE CAP GROWTH FUND

COMPANY: Zimmer Holdings
TICKER: ZMH (NYSE)
PRICE: $68.42 (as of 4 p.m. yesterday)
52-WEEK RANGE: $60.19-$86.65
MARKET CAPITALIZATION: $16.95 billion

Tom Galvin is a senior portfolio manager with the Excelsior Large Cap Growth Fund (UMLGX) and is the head of growth investing at US Trust. Zimmer Holdings designs, manufactures, and markets reconstructive orthopedic implants both in America and internationally. Mr. Galvin spoke to David Dalley of The New York Sun about why he thinks the stock could increase by as much as 17% over the next year.

What does Zimmer do?

It’s the largest manufacturer and distributor of orthopedic and reconstructive implants, specifically for knee-, hip-, and also back-related joint products.

Why is it a strong buy?

It’s a play on demographics with regard to the aging population.The stock has come down from nearly $90 a year ago, and we believe that it’s now selling at a discount to its growth rate, which we think should average in the vicinity of 16% to 20%. This is a company whose unit volume is increasing by 8% to 10% per year. We think the stock ought to be priced somewhere around $85 sometime in the next year to 18 months.

The stock price has been weak lately. Why’s that?

There are two main reasons. First, pricing, which had been growing by about 6%, is now not growing at all or slightly shrinking. Primarily that’s because the mix of products has been changing and a few new ones have been introduced. There’s also been some attention by other suppliers that are trying to keep a lid on price increases in this area because it has been growing so rapidly.

Currency was also a drag last year. The strength of the dollar reduced revenues by 3%, but we’re not expecting a dramatic strengthening going forward, so that shouldn’t be an issue.

We don’t expect the price constraints to be an issue in the future. If you look at more of a 12-year dynamic, pricing increases have averaged 2% to 3% per year, which is roughly in line with the CPI. But for a couple years, from 2002 to 2004, the increases were roughly double that. So the reductions now just represent a move toward a more normal level.The price issues are in the past.

What are you expecting in terms of growth this year?

We’re expecting revenue growth of about 5% to 6% in the first half of this year, and we’re expecting closer to 10% in the second half. They have a couple new products launching – for example, a new ceramic hip – and with the price and currency woes now behind them, growth should pick up significantly.

You basically have a company, which is a leader in the industry, which has a global presence, a low cost structure, no debt, and a return on equity of 17%. Demographically, they’re in an enviable spot too. The aging population and weekend warriors continue to bear down on their joints, so to speak, and that leads to sustainable growth for the company. Zimmer represents about 4% of our portfolio, and we’ve been adding to it recently.

You need to be somewhat patient in this scenario. The year is back-end loaded in terms of growth. We’re expecting growth in the second half of the year to be double that of the first. Investors are a bit weary right now. The company is going to have to meet those growth expectations and produce an attractive full year of earnings. And when they do, the market will start taking real notice.