With a majority of the major orthopedic and medical technology companies having reported now, it's pretty clear that key markets like orthopedics and surgery are still seeing pretty sluggish performance. Yet the stocks of companies like Stryker (SYK), Zimmer (ZMH), and Covidien (COV) have done pretty well over the last year, as investors look for performance to rebound and return to names that were beaten up a little too much. Though I still think there's money to be made in Stryker's stock, the gains are likely to be more gradual from here.
Confusing Numbers in the First Quarter
Stryker's first-quarter results were not the cleanest or most easily digestible we've seen from this company. In particular, both foreign currency and a change in the number of selling days interfered with easy comparisons.
Revenue was up about 1% as reported, with the company coming in just shy of the average estimate. On an organic basis (including adjusting for the selling days), though, revenue was up about 5%. Revenue in the recon business was up 1% as reported and about 5% organic, as the company continues to see sluggish hip and knee performance (particularly overseas) and strong results in trauma and extremities.
Medsurg saw flat reported revenue, with adjusted revenue growth more akin to the recon number. Patient handling was a little better than expected, but basic conditions in instruments and endoscopy were still just OK. Neuro and spine continues to be the growth driver for Stryker, as a relatively weak reported performance in spine was offset by ongoing double-digit growth in neuro.
Stryker has continued to make progress with its margins. Gross margin did decline 30bp from the year-ago period and about 80bp sequentially as the excise tax took effect, but the company did deliver a small (20bp) beat relative to expectations. Operating income fell 2%, though, and the company slightly disappointed on operating margin due to higher R&D spending.
Holding Its Own, but Not Going Anywhere Fast in Core Recon
Relative to Biomet and Johnson & Johnson (JNJ), Stryker's recon performance was a little soft. Continuing a trend, Stryker is actually doing pretty well with U.S. hips and knees, but the overseas performance continues to lag. This is not a new development, nor is it one that the company can reverse in just one or two quarters, but management has acknowledged it as an issue it must address.
Outside of hips and knees Stryker is doing alright, but I wonder about the sustainability. Stryker has definitely picked up trauma business lost by a JNJ/Synthes recall, but the strength in extremities has been impressive beyond that. Biomet, too, had good results here. So I'm curious to see whether Tornier (TRNX) and Wright Medical (WMGI) see similar growth, or whether they're losing market share. In any case, while I'm happy to see the growth here, it doesn't overshadow the work Stryker needs to do in its global hip and knee business.
Surgical Seems to Be Gaining
With reports from JNJ and Intuitive Surgical (ISRG) in hand, it looks as if JNJ is a share-donor in the surgical tools space right now. This is not exactly new, and it does suggest that Covidien is also grabbing share. As a reminder, Covidien and Stryker have both been working on rolling out new minimally invasive tools that allow surgeons to perform procedures similar to what can be done with the Intuitive Surgical daVinci robot, but without the need for the $1.5 million robot and at procedure prices about one-third less. That's not the only thing driving Stryker's surgical business, but it is a driver worth mentioning.
The Bottom Line
Since acquiring Boston Scientific's (BSX) neuro business, Stryker hasn't made a lot of flashy moves. Instead, there have been a lot of common sense steps like a greater focus on manufacturing and distribution efficiency and acquiring Trauson with an eye toward ultimately leveraging this company's low-cost implant business in China (and other emerging markets). These moves should bear fruit in the years to come, and if coupled with a better European recon business, should lead to good profit leverage.
I'm still looking for mid- to high-single-digit free cash flow growth from Stryker over the next decade. That discounts back to a per-share fair value of about $72. To me, then, that suggests that Stryker can continue to outperform its peer group, making it a worthwhile stock to consider at these levels.