Does Stryker Need Further Reconstruction?

By Stephen D. Simpson, CFA | April 21, 2011 AAA

Stryker (NYSE:SYK) has been relatively active of late in recrafting its business, but the first quarter's results suggest that management's work may not be done yet. Stryker remains a good core holding for GARP-oriented investors, but management is going to need to deliver better results on the "guh" side of GARP to get the Street excited again.

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An OK (but Not Great) Quarter
Stryker did not disappoint, per se. But analysts are not going to be thrilled with the company's numbers nevertheless. Revenue grew more than 12% on a reported basis, with core constant currency organic revenue growth of 4%. That continues a rather unfortunate trend of unimpressive growth that stretches back a few years now.

While that revenue growth met expectations, the composition is the tricky bit. The orthopedics business was flat, while the MedSurg unit was up more than 12%, with double-digit growth in instruments and endoscopy. Even though companies like Johnson & Johnson (NYSE:JNJ) and Covidien (NYSE:COV) have long done well in endoscopy and its a good repeat business, other aspects of MedSurg are more tied to hospital capital budgets - that, and the margins, are largely why analysts don't love that unit so much.

Speaking of profitability, Stryker saw better gross margin on an adjusted basis. Adjusted operating income rose 10%, but margins still contracted all the same. So, the company met its numbers but not in a way that is going to have anybody pounding the table.

Ortho - Where's the Growth?
On a constant currency basis, Stryker's orthopedics business finished the quarter running in place. Growth in hips was offset by contraction in knees, while spine and trauma ticked up a bit. Overall, the company's results were not so much different than JNJ's, but it is disappointing all the same that the industry hasn't recovered much yet. Moreover, Zimmer (NYSE:ZMH) and Smith & Nephew (NYSE:SNN) seem to have the momentum right now. (For related reading, see A Checklist for Successful Medical Technology Investment.)

With JNJ reportedly in talks to acquire Synthes, it is worth wondering if Stryker will do anything to respond. Much as Stryker might like to boost its spine and trauma businesses, an acquisition of Synthes would be nearly a merger of equals, so likely a bigger bite than Stryker wants to take. A name like Alphatec (Nasdaq:ATEC), NuVasive (Nasdaq:NUVA), or Orthofix (Nasdaq:OFIX) could be more digestible, though, as well as Wright Medical (Nasdaq:WMGI) if the company wants to expand its extremities business.

Other Areas Doing Better
The MedSurg business is doing pretty well, and investors looking for a read-through might want to look at Hill-Rom (NYSE:HRC), a company that is likewise heavily involved in equipment like hospital beds. Elsewhere, the acquisition of Boston Scientific's (NYSE:BSX) neurovascular business seems to be going well, but this unit will still need some time and work.

The Bottom Line
Stryker's current price makes it an attractive hold and a borderline buy. It would help sentiment if the company could reassure the Street that it has some growth drivers about to take off, but history suggests patient investors need not worry about the company's long-term growth prospects. People are still getting older and their joints are still breaking down, to say nothing of the solid opportunity the company has in the surgical tools and neurovascular spaces. Couple this with a willingness to return capital to shareholders, and this is an attractive name for a multi-year horizon. (For more, see Multiple Value Creation Opportunities For Styker.)

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