Steering Clear of Stryker; Larger Medical Device Cos Are Better Positioned

An anonymous reader asked the following question in a comment:

Since you're in health care what do you think of Stryker…not a dividend monster by any means but maybe some upside soon?

I actually talked a little about this company in some previous comments, but I can republish them here and go into a little more detail.

For those new to this stock, Stryker (SYK) is a healthcare company that develops and manufactures specialty surgical and medical products. Specifically, the company's products are used for orthopedic implants, bone cement, bone repair related to trauma, powered surgical instruments, endoscopic systems, craniomaxillofacial (jaw) fixation devices and they also provide some outpatient physical and occupational rehabilitation services.

It is a company I'm familiar with both professionally and as a prospective investor, but a stock that I have never owned.

The attraction of late towards this stock by some investors has been three-fold:

• The valuation of the company has fallen in the current market from $70 per share to $40
• The company has a strong history of raising dividends on a regular basis
• It has an established track record of growth in operations, product development & financial strength.

Recently the company has provided their earnings guidance for 2009 which I feel is a little on the ambitious side for a few reasons. I highlighted this as an area of caution in my public comments on the FWF and while I still expect the company to report a profitable 2009 growth is likely to be nearly stagnant considering the economic environment.

A big component of their earnings comes from orthopedic products and in difficult economic times I look to this segment of the healthcare market as economically sensitive. Orthopedic surgeries are required if life threatening, but the majority are considered elective (non-urgent) and are either paid as out of pocket expenses or through insurance in the US.

A company that you could compare Stryker to in this current market environment might be National Dentex (NADX), which has experienced a more significant fall of their share price. NADX is a much different company since they provide denture products/services to patients as an elective product and are not seen as an essential in an environment where budgets are tight. Individual patients who pay out of pocket for their surgery or pay sizable deductibles may prolong their surgeries due to difficult times. A bad knee, despite the discomfort, may be financially unviable for someone who is on fairly stable financial ground, but is watching their investment portfolio, home value and job stability falling precipitously the past 24 months.

I don't foresee a massive contraction in sales, but likely sales growth will slow considerably from what the company has achieved during the past 3-5 years. Medical supply/device companies that I feel are in a much stronger position would be GE, JNJ, BAX and BDX. With BAX and BDX specifically, an investor is getting a lot more secure revenue stream from sales in a depressed market because their products are most often single use items (IVs, catheters, tubing) and used in significantly higher volumes. The valuations of the companies are not as cheap as other medical supply companies, but their products have what I consider to be perpetual demand in a market where few smaller firms have gained much traction. Elective surgeries, in my opinion, are something that I anticipate people putting off for 6-18 months and this has the potential to negatively impact smaller medical device/supply companies over the interim.

Stryker has a market capitalization far above smaller companies in its field so there is also the potential for consolidation in the industry as prices of firms with prized intellectual property or developing product streams remain at depressed levels. If you're an investor who has a long investing horizon (5-10 years), Stryker has an excellent track record of performance, dividend growth and is situated with a market demographic that clearly will have increased demand in the future. I expect sales growth will be in the low single digits rather than the guidance provided by the company of 6-9%.

For almost any healthcare company I own or might consider owning, I have a strict requirement: it has to pass a litmus test on the consumer. What I've found in my own research and experience is that healthcare companies exposed to markets with uncertain demand can get into a lot of trouble when you least expect it. Companies with a diversified portfolio of products that allow them to meet changing economic conditions are best suited when demand for elective category procedures dries up.

It does appear as if the company is building a base technically at its current valuation, but for the short-term investor I would likely steer clear of the company until the economic environment of 2009/2010 is clearer. I anticipate Stryker's weaker competitors will come under increasing pressures over the next six months in both sales and costs. While this may impact the earnings of the industry, Stryker is the best situated to tread water for the next year or so. There are other ortho-based healthcare companies an investor may want to look at that are more diversified in the elective care space, but the risk reward profile of a company in this market is much higher than I would assign to a larger, more diversified medical supply/device company.

One additional threat that has recently surfaced is the proposed legal action being taken against Stryker and a number of co-defendants.

As always an investor should perform their due diligence. As part of a diversified portfolio of healthcare companies I feel Stryker is a worthwhile addition, but my preference would remain on the larger companies in the space that have more stable access to patient care than expensive elective procedures.

Disclosure: I hold shares in GE, JNJ, BAX and BDX

Comments

[andyn:]

Agree...SYK is heavily dependent on ortho products as its cash cow and that will slow down massively in the next 2 years.
They are trying to diversify into other sectors like endoscopy, hospital comm systems but that doesnt bring in the kind of margins to keep the profit going at the levels they wanted i.e. earnings growth of 20%.
One way for them to increase profits might be to layoff workers and that might occur in 2009. The stock might languish at these levels for the next 2 years before demand picks up or management takes some aggressive action.

Jan 20 09:52 AM

[Brad Ferris:]

Thanks for the comment andyn. I still think the company will post a profitable 2009, but with expectations high I feel the market could possibly punish the stock if it's not able to meet its targets.

Jan 20 03:11 PM

[Captainess:]

Agree as well. The healthcare industry is not recession proof; couple a bad economy with spiraling medical costs and higher premiums and co-pays, people are more weary of what procedures they elect to undergo. Botox and LASIK are also dropping in demand, which further demonstrates that elective procedures are, as Brad writes, economically sensitive.

Jan 20 10:32 PM

[Brad Ferris:]

Captainess,

I like your reference to stocks/industries as economically sensitive. I often refer to them as "Recession Resistant" rather than the frequently used "proof". I wrote about this on my blog a few months ago also. Proof gives the perception that something is invincible and no company has that luxury (to my knowledge). As great as a moat may be, it is still susceptible to economic pressures from costs, revenues & inflation.

Jan 20 11:35 PM

[User 343951:]

I totally disagreed. The stock is establishing the new support at $40. If the earnings is good, it will move upward to $42 or $43. Beyond this level the economic ambinance will be an important factor for the stock to pass $45.

I went to a hospital the other day, My hospital bed was made by Stryker. The ediscopic equipment was made by Stryker. Stryker is more than just selling products for Othopedic implants. The current price is sitting at six-year low in concert with the entire market while the company was able to increase dividends and generate organic growth. Moreover, I seldom see a person pursuing Othopedic surgery as elective. When one needs it, one will do it. Nobody can sustain a pain on the neck.

GE is not much a medical tech company but is more likely a financial service company. I feel that GE is heading to $10 and slashing dividend by 50%. Between GE and SYK, SYK is a much better choice.

IMHO, the best in the whole group of medical devices is ABT. However, ABT is not affected by the the down-draft. It is not a bad idea to put a piece of pie in SYK.

Jan 25 03:24 AM

[Mark G:]

From the little I've read, Stryker is strongly diversified in hospital equipment. Brad, how much did this factor into your opinion/analysis on them? 343951, I'd be interested to hear more about what you think too.


On Jan 25 03:24 AM User 343951 wrote:

> I totally disagreed. The stock is establishing the new support at
> $40. If the earnings is good, it will move upward to $42 or $43.
> Beyond this level the economic ambinance will be an important factor
> for the stock to pass $45.
>
> I went to a hospital the other day, My hospital bed was made by
> Stryker. The ediscopic equipment was made by Stryker. Stryker is
> more than just selling products for Othopedic implants. The current
> price is sitting at six-year low in concert with the entire market
> while the company was able to increase dividends and generate organic
> growth. Moreover, I seldom see a person pursuing Othopedic surgery
> as elective. When one needs it, one will do it. Nobody can sustain
> a pain on the neck.
>
> GE is not much a medical tech company but is more likely a financial
> service company. I feel that GE is heading to $10 and slashing dividend
> by 50%. Between GE and SYK, SYK is a much better choice.
>
> IMHO, the best in the whole group of medical devices is ABT. However,
> ABT is not affected by the the down-draft. It is not a bad idea
> to put a piece of pie in SYK.

Jan 25 11:53 PM

[Brad Ferris:]

Stryker is diversified in about a 60/40 split between their large Ortho products & other medical supply/device products. They are still largely dependent on Orthopedic implants for the majority of their business and in an economically sensitive environment companies (hospitals) may be more conservative in their capital expenditures for medical stretchers, endoscopy supplies or OR materials.

The point I am making is no company is economically insensitive and when evaluating Stryker an investor needs to be aware of all revenue sources for the company and the economic challenges each segment faces.

Jan 27 10:38 PM

[User 356779:]

Couple things to think about:

1. The orthopaedic implant market is growing at 10 - 11% per year and will continue to grow due to baby boomers. Even if some patients shy away due to the ecomony, there will be plenty of others who will go through with the procedure.

2. Stryker is growing its market share in knees, with growth numbers significantly outpacing market. Same goes for trauma and joint preservation.

3. Very healthy product pipeline

4. History of being financially conservative.

5. $2bln in cash. Opens up opportunities.

Feb 13 05:39 PM

[User 356779:]

Market growth rates for orthopaedics, specificly reconstructions, are upwards of 10%. This is due to the baby boomers.


On Jan 20 09:52 AM andyn wrote:

> Agree...SYK is heavily dependent on ortho products as its cash cow
> and that will slow down massively in the next 2 years.
> They are trying to diversify into other sectors like endoscopy, hospital
> comm systems but that doesnt bring in the kind of margins to keep
> the profit going at the levels they wanted i.e. earnings growth of
> 20%.
> One way for them to increase profits might be to layoff workers and
> that might occur in 2009. The stock might languish at these levels
> for the next 2 years before demand picks up or management takes some
> aggressive action.

Feb 13 05:43 PM