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Stryker Needs A Growth Resurfacing
Stryker (NYSE:SYK) used to be on of the glory stocks of the medical technology sector. Every year, they churned out 20% earnings growth no matter what, and a lot of money was lost betting that the trend would end. Nowadays, though, that seems like a distant memory and the prime question about Stryker is whether they can recapture growth and leadership in their markets.
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The Quarter that Was
June was not a very encouraging quarter for Stryker fans. Revenue was up 7% overall and that was just shy of analysts' average guess. The trouble, though, was in the details. The MedSurg business showed 15.9% increase in sales as hospitals played catch up on the purchase of equipment like hospital beds; purchases that were postponed during the 2008-2009 troubles. The company's core orthopedics business, though, was only up a bit more than 1%, and hips, knees, and spinal care were all very weak. In fact, I believe this is the weakest result Stryker has produced here since they bought Howemedica from Pfizer (NYSE:PFE) in 1998.
There was a little more cause for optimism down the income statement. Gross margin improved by over 200 basis points and the company's EBITDA margin improved by 161 basis points, leading to EBITDA growth of 13%. All in all, Stryker met its EPS estimates.
Where To from Here?
Unfortunately, investors will need to wait a bit before they can put Stryker's results in their proper context. So far, there is limited information about how the ortho market fared in the second quarter. If Zimmer (NYSE:ZMH), Smith & Nephew (NYSE:SNN), and Wright Medical (Nasdaq:WMGI) report stronger results, Stryker's talk of a sluggish market will seem less comforting and investors will have renewed fears about market share loss. Of course, institutional investors being what they are, if these other companies report sluggish results, the whole sector may see a sell-off because these managers will worry about the momentum in the industry!
Longer term, it is hard not to be positive on Stryker. This company produces prolific cash flow and always has the option to leverage that cash into R&D and/or acquisitions. That means that management has the opportunity (*and* the obligation) to stay on top of trends in the orthopedics space and be among the pioneers in new products and new markets.
On top of that, there is the oft-repeated bit about the aging ofAmerica Western Europe and Japan
The Bottom Line
The downside to that positive scenario is that as Stryker grows, those trends become less and less enabling for the company and more like essentials. What I mean is this - Stryker is a big company now and it simply is not easy to produce double-digit growth on that scale (well, unless you are Apple). Moreover, governments around the world are increasingly the ultimate consumer of healthcare (the ultimate payor, anyway) and I have to think they are going to hold a hard line on pricing as entitlements chew up national budgets. (For related reading, see Investing In The Care Side Of Healthcare.)
I have long liked Stryker, and I still do. The stock seems undervalued by about 25-30% to me on a long-term basis. Looking past my own cash flow modeling, this is a company that consistently delivers double-digit returns on capital, returns capital to shareholders, produces a double-digit cash flow margin, and trades under three-times revenue and 10-times EBITDA (typical valuation breakpoints for larger med-tech companies). All in all then, while the company has something to prove again, investors could certainly do alright with one as part of a diversified portfolio. (For more, see A Checklist For Successful Medical Technology Investment.)
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IN PICTURES: 20 Tools For Building Up Your Portfolio
The Quarter that Was
June was not a very encouraging quarter for Stryker fans. Revenue was up 7% overall and that was just shy of analysts' average guess. The trouble, though, was in the details. The MedSurg business showed 15.9% increase in sales as hospitals played catch up on the purchase of equipment like hospital beds; purchases that were postponed during the 2008-2009 troubles. The company's core orthopedics business, though, was only up a bit more than 1%, and hips, knees, and spinal care were all very weak. In fact, I believe this is the weakest result Stryker has produced here since they bought Howemedica from Pfizer (NYSE:PFE) in 1998.
There was a little more cause for optimism down the income statement. Gross margin improved by over 200 basis points and the company's EBITDA margin improved by 161 basis points, leading to EBITDA growth of 13%. All in all, Stryker met its EPS estimates.
Where To from Here?
Unfortunately, investors will need to wait a bit before they can put Stryker's results in their proper context. So far, there is limited information about how the ortho market fared in the second quarter. If Zimmer (NYSE:ZMH), Smith & Nephew (NYSE:SNN), and Wright Medical (Nasdaq:WMGI) report stronger results, Stryker's talk of a sluggish market will seem less comforting and investors will have renewed fears about market share loss. Of course, institutional investors being what they are, if these other companies report sluggish results, the whole sector may see a sell-off because these managers will worry about the momentum in the industry!
On top of that, there is the oft-repeated bit about the aging of
The Bottom Line
The downside to that positive scenario is that as Stryker grows, those trends become less and less enabling for the company and more like essentials. What I mean is this - Stryker is a big company now and it simply is not easy to produce double-digit growth on that scale (well, unless you are Apple). Moreover, governments around the world are increasingly the ultimate consumer of healthcare (the ultimate payor, anyway) and I have to think they are going to hold a hard line on pricing as entitlements chew up national budgets. (For related reading, see Investing In The Care Side Of Healthcare.)
I have long liked Stryker, and I still do. The stock seems undervalued by about 25-30% to me on a long-term basis. Looking past my own cash flow modeling, this is a company that consistently delivers double-digit returns on capital, returns capital to shareholders, produces a double-digit cash flow margin, and trades under three-times revenue and 10-times EBITDA (typical valuation breakpoints for larger med-tech companies). All in all then, while the company has something to prove again, investors could certainly do alright with one as part of a diversified portfolio. (For more, see A Checklist For Successful Medical Technology Investment.)
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by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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