Stryker (NYSE: SYK ) has been a fairly strong stock this year, and why not? The company addresses several attractive markets within med-tech and shown a willingness (and capability) to effectively deploy capital toward business-building M&A transactions. Although price weakness, particularly in ortho, is a concern and the stock's valuation isn't a screaming bargain, Stryker likely won't be a bad place to be relative to the sector.
No blowout, but a good enough Q2
Stryker reported revenue growth of nearly 7% this quarter, just slightly ahead of expectations, and a "same-day" organic sales growth rate of 6.3%. Though it is still relatively early in the earnings reporting cycle, that is almost certainly going to be one of the strongest growth rates for the large med-tech sector this quarter and testament to Stryker's leverage to growth markets within med-tech.
Orthopedics revenue rose more than 6% this quarter, as 2.5% growth in major joint recon was sweetened with 11% growth in trauma and extremities. That recon performance is the worst so far of the companies that have reported (Johnson & Johnson was up closer to 3% and Biomet was up 4%), but it was fairly close to expectation. U.S. hips and knees did pretty well (up 6% and 7%, respectively), but the OUS business remains challenged (down 3% and 6%) and pricing remains more challenging than analysts had been expecting (down 3% and in line with Johnson & Johnson's comments).
Medsurg was up 9%, with Endoscopy leading the way with growth of over 17%. Even without the benefit of acquisitions, Endoscopy would have still grown about 9% and Instruments grew more than 7% with the reintroduction of the Neptune waste management system (and apparently taking share back from Zimmer). Medical was up about 4% and management noted that overall hospital demand for equipment is still fairly soft.
Neuro/Spine was mixed – overall revenue was up 4%, with Neuro up more than 8% and Spine down almost 2%. This is the third straight quarter of sequential growth erosion in the spine business and the company is hurting not only from a lack of scale (particularly in minimally invasive) but a loss of reps.
Below the revenue line, Stryker's performance was mixed but with a positive lean. Gross margin was disappointing-down 150bp and more than a half point below expectations – as lower pricing took a bite. Management did meaningfully better on operating expenses (particularly SG&A), though, and operating income rose 2%, beating estimates by about 2% and the operating margin was 40bp higher than the Street expected.
An active acquirer and likely to remain so
Stryker has long been willing to acquire what it needs, wants, and doesn't have the patience to build on its own. The acquisition of Boston Scientific's neuro business has already been a big win for the company and while the MAKO acquisition has yet to really hit its stride, management remains confident in the long-term potential of robotics in orthopedic surgery (and will be introducing new hip and knee implants for the system in 2015).
Most recently the company acquired Small Bone Innovations, a significant player in lower extremities with the STAR total ankle. While I was disappointed that Stryker acquired SBI, in part due to what I believe will be declining momentum in the ankle business and also due to my wish to Stryker acquire Wright Medical Group (which I own), I can't argue that the acquisition won't meaningfully improve the company's position in lower extremity recon.
Looking ahead, Stryker is likely not done yet. Management has mentioned a desire for more scale in the spine business on more than one occasion and either NuVasive or Globus would fit the bill. Stryker definitely needs more scale in spine to compete effectively with Johnson & Johnson and Medtronic, and either target would significantly upgrade the business.
I also expect Stryker to at least consider Smith & Nephew (NYSE: SNN ) again. With Medtronic acquiring Covidien, I don't see them as a likely bidder for Smith & Nephew and adding scale in major joints and sports medicine/arthroscopy, as well as adding the wound care business, would fit the current themes in the med-tech space. What's more, with Zimmer looking to acquire Biomet, this could be a good time for a large deal; large deals almost always bring disruptions and dealing with those while another large rival is going through the same challenges may mitigate the damage.
The bottom line
Stryker looks like an OK, but not great, investment prospect today. I definitely like its above-average growth and the shares do not look expensive on forward sales, but the long-term cash flow outlook is not quite strong enough to make it a strong buy. I consider Stryker to be a comparatively good option in a sector that doesn't offer a lot of bargains, and a good company for the long term, but it's hard to get really excited about the share price at today's level.
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