Stryker's Diversification Paying Off

By Stephen D. Simpson, CFA | July 22, 2011 AAA

The management of medical device and equipment maker Stryker (NYSE:SYK) has always seemed to have an uncanny knack for findings ways of pulling growth out of its hat. In a pretty uninspiring market for orthopedic implants, Stryker is finding growth in hospital equipment and acquisitions. With a strong market position and good long term prospects, this is one of the first names that investors lacking exposure to health care should consider.

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A Surprising Second Quarter
Stryker's consolidated results were not so surprising, but how the company managed to get from A to B was a little surprising. Revenue rose about 16% on a reported basis, with 12% constant currency growth.

Orthopedics was no great star, but the unit still produced 2% constant currency growth - a result that was incrementally better than the numbers seen at Biomet and Johnson & Johnson (NYSE:JNJ). Medsurg was more surprising, though, with 12% growth fueled by a surge in sales of hospital products like beds. Last and not least, Stryker delivered some solid results in the neuro-spinal unit as well.

Margins were so-so this time around. Gross margin slid about 260 basis points, with much of that coming from foreign currency effects (and excluding an inventory step-up charge). Adjusted operating income rose almost 4%; core operating expense items were not too badly out of shape, but there was higher amortization expense this quarter.

Looking Across to Other Stories
Investors in Hill-Rom (NYSE:HRC) should be feeling pretty good about Stryker's numbers. Certainly there is some risk that Stryker is capturing share in the bed and patient movement market, but it looks more like this is part of a long-awaited refreshment cycle in hospital capital equipment. That could also be incrementally positive for companies like Varian (NYSE:VAR) and ZOLL (Nasdaq:ZOLL). Clearly there are major differences between hospital beds, radiation oncology systems and external defibrillators, but all represent capital purchases that hospitals tend to delay when times are tough and recapture when budgets get better.

As for the ortho market, the read-throughs are a little more unclear. Zimmer (NYSE:ZMH) should be in mostly the same boat as Stryker as both have similar new product and pipeline positions. Likewise, decent spine numbers at Stryker may offer some encouragement for companies like Nuvasive (Nasdaq:NUVA) and Alphatec (Nasdaq:ATEC).

Still a Growth Story
Stryker is a long way from giving up on its identity as a growth company. True, orthopedic implants are not likely to be a major growth market again as there is just too much competition and too much pricing pressure from national payors. But it is a cash-rich business and Stryker can use that cash to acquire or invest in new opportunities - like the company's acquisition of Boston Scientific's (NYSE:BSX) neurovascular business or Memometal and its products in orthopedic extremities.

The Bottom Line
It's probably a fool's errand to make bold predictions about Stryker's next target or growth market, especially as the BSX neurovascular acquisition was something of a surprise. That being said, it seems fair to assume that it will be an under served market with long-term growth prospects. Likewise, there does not look to be any reason to abandon the idea that Stryker will be a solid grower for some years to come.

Investors may be worried about the risks in FDA approval process reform and in the reimbursement environment, but Stryker has navigated these before. In terms of quality and value trade-offs, Stryker is one of the best ideas available today in large-cap med-tech. (Over time, intelligent and disciplined risk-seeking behavior can produce substantially above-average returns. See How To Construct A High-Risk Portfolio.)

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