SurModics Downgraded

We recently downgraded our recommendation on SurModics (NASDAQ:SRDX) to Underperform. Although SurModics’ first quarter earnings (after adjustments) of fiscal 2010 came in at 5 cents above the Zacks Consensus Estimate, we are concerned about the company’s top line growth. 

SurModics earns more than 60% of its revenues from the cardiovascular segment. Although this segment reported a marginal year-over-year growth of 3% during the first quarter of 2010, the past trend has not been as encouraging due to severe competition in the stent market. We believe the competitive landscape in the stent market will keep revenues of the cardiovascular segment volatile. 

Moreover, we are concerned about the termination of its agreement with Merck (NYSE:MRK), which related to the development and commercialization of a drug delivery system for the treatment of serious retinal diseases. Although Merck’s decision was made following a strategic review of its business and product development portfolio and did not relate to the safety or effectiveness of any of SurModics’ drug delivery systems, we remain concerned about the company’s current partnership programs. Additional terminations of partnership agreements will hit the company’s top line. 

Although we are quite upbeat about SurModics’ agreement with Roche to develop and commercialize a sustained drug delivery formulation of Lucentis (ranibizumab injection), we doubt its ability to record revenue growth in the near future. 

Recent revisions in 2010 earnings estimates for SurModics have followed a strong downward (negative) bias. Over the last 30 days, 7 of 8 analysts following the stock have reduced their estimates for fiscal 2010, with only one analyst moving in the opposite direction. If annual results come in line with expectations, 2010 EPS would be 38% below the year-earlier level. 

For the second quarter of 2010, the Zacks Consensus Estimate is 16 cents, representing a year-over-year decline of 33.3%. Over the last 30 days, 6 of the 8 analysts following the stock have reduced their estimates for the quarter, with 1 analyst doing the reverse. Since the termination of its agreement with Merck, SurModics has witnessed a steep decline in contribution from the ophthalmology segment, hitting its top line, a trend we expect to continue in the forthcoming quarters.