SurModics Stays Neutral - Analyst Blog - Merck & Co (NYSE:MRK), Johnson & Johnson (NYSE:JNJ)

SurModics (SRDX), headquartered in Eden Prairie, Minnesota, is a provider of surface modification and drug delivery technologies to the healthcare industry. Following the changes in operational structure affected in 2008, the company currently operates through the following business units: cardiovascular, ophthalmology, SurModics pharmaceuticals (constituting the "therapeutic" segment) and In Vitro Technologies (diagnostics).

Surmodics performed disappointingly in the most recent quarter. Earnings came in at $0.11 per share, short of the year-ago earnings by $0.09.

(Read our full coverage on this earnings SurModics Falls Short)

We are encouraged by SurModics' license agreement with Australian company Clinuvel Pharmaceuticals. The deal allows SurModics' pharmaceuticals unit to license some of its biodegradable polymer implant technology to Clinuvel. The market opportunity for Clinuvel's afamelanotide for ultraviolet (UV) related disorders being evaluated by the company is estimated by the Royal Bank of Scotland (RBS) to exceed seven million patients across the globe.

We are also encouraged by the company's agreement with NuPathe Inc. in late 2009 to develop novel long-acting treatments for Parkinson's. The incidence of the disease, which currently affects approximately 1.4 million people in the US, Europe, and Japan , is on the rise. Such agreements should bring in additional revenues for the company.

Moreover, SurModics' strong financial position is another positive for the company. The company exited the most recent quarter with cash and investments of$54.8 million with no debt burden. The company generated operating cash flow of $4.4 million during the quarter. During the nine months ended June 30, 2010, SurModics repurchased stock worth approximately $2 million. We believe the strong cash position augurs well for further acquisitions in addition to investing in current business and rewarding shareholders in the form of share repurchases. Furthermore, the growth by acquisition strategy of the company has helped it broaden its customer and revenue base.

However, the severe competition in the stent market concerns us. Global sales of Cypher stent (marketed by Johnson & Johnson's (JNJ) Cordis division) declined 29% year over year in the most recent quarter. Moreover, the early stage of the pipeline also bothers us. Additionally the disappointing performance of the ophthalmology segment (revenues from the segment declined 68% sequentially in the most recent quarter) ever since the termination of the company's agreement with Merck & co. (MRK) also bothers us. Additional terminations of partnership agreements will hit the company's top-line.

We believe that SurModics' current valuation adequately reflects its fairly balanced risk/reward profile. We see limited upside from current levels. We have a Zacks #3 Rank (short-term Hold recommendation) on SurModics' shares. This implies that SurModics is expected to perform in line with the broader US equity market over the next 1 - 3 months.

We are Neutral on the stock in the long-term, which indicates that SurModics' shares are expected to replicate its short-term performance, but over 6+ months. Consequently, we advise investors to retain the stock over the time-period.