Stryker: Does The Medical Device Company Belong In Our Dividend Growth Portfolio?

| About: Stryker Corporation (SYK)

Summary

Even with impact of currency exchange rates, Stryker was able to have organic growth of 6.4%.

The Dividend Contender has raised dividends 23 straight years.

The five-year average dividend growth rate is more than 18%.

Introduction

Stryker (NYSE:SYK) is one of the world's leading manufacturers of orthopedic products and surgical equipment. The company can trace the its roots back to Doctor Homer Stryker of Kalamazoo, Michigan. Stryker used the basement of a local hospital to create and manufacture his inventions that would mark the beginnings of the company. His first product, an oscillating saw, made the removal of a plaster cast much easier to perform. The process of removing a cast from a patient's arm or leg used to be a grueling process for both patient and doctor. The oscillating saw made the process take just a few minutes. It was inventions like this that allowed Stryker the company to become a dominating player in the orthopedic sector.

According to S&P Capital, the company has three divisions: The Orthopedics segment produces prosthetic knee and artificial hip replacements as well as nails, pins, screws and plates used to repair bones and joints that are injured or fractured from sudden trauma. The MedSurg Products portion of the company sells instruments used to drill and cut bones to prepare for hip and knee replacement surgery. This section of the company also manufactures medical products such as video cameras, light sources and surgical instruments. The third segment of the company is the Neurotechnology & Spine Products. As you might expect from the title, this part of Stryker is responsible for products related to the spine, consisting of implant systems as well as equipment used to perform surgery on the spine. The Neurotechnology & Spine division also produces the plates and screws for surgeries that repair bones in the head, face, and hand.

Full Year and Fourth Quarter Results

Stryker reported 4th quarter and full year 2015 results on Monday, January 26th, 2016. The company stated in the conference call that 70% of sales from the United States. Because a sizeable amount of sales come from outside the U.S., Stryker is still subject to the impact of foreign currency exchange rates. For the fourth quarter, the company had net sales of $2.7 billion. This was 3.7% higher than the previous quarter. The fourth quarter results include a 3.2% negative impact on sales due to currency exchange rates. Even with the currency impact, all segments of the company still reported growth quarter over quarter. Orthopedics sales grew 3.3%, MedSurg 3.0% and Neurotechnology and Spine 6.5%. In constant currency, these divisions had sales growth of 7.1%, 5.6% and 9.9% respectively. Overall, the company experienced organic growth of 6.4%. Solid numbers for a company experiencing difficult currency headwinds.

For the full year, the company grew sales to $9.9 billion. Including currency impact, this was good for a 2.8% growth in sales year over year. Without the currency impact, sales would have grown 7.0% for 2015. Including the impact of currency exchange rates, Orthopedics, MedSurg and Neurotechnology grew sales 1.7%, 3.0% and 5.0% respectively for the full year.

Earnings for the quarter came in at $1.56 per share, which was at the higher end of the company's initial quarterly guidance. Earnings for 2015 came out to $5.12, which was 8.2% higher than 2014. Stryker also provided guidance for 2016 and projects to earn between $5.50 and $5.70. This would be an increase of 7.5% to 11.5% in earnings per share compared to 2015. This forecast includes a negative impact from foreign exchange to a tune of $0.12 to $0.13 a share. Due to the uncertainty with Chinese and Brazilian economies, the company expects organic sales growth to be near 5% for 2016.

Free cash flow for 2015 was $900 million, which is half of the $1.8 billion the company produced in 2014. A major cause of this decline stemmed from Stryker having to pay for the recall and settlements of two of its artificial hip implant systems, the Rejuvenate and ABG II Modular-Neck Hip Stems.

According to Google Finance, Stryker paid out $521 million dollars in dividends in 2015. Even though Stryker had 50% less cash flow in 2015 than in 2014, the company still had more than enough cash to cover the dividend. While the loss of cash flow due to recall and settlements isn't ideal, this situation shows that company's finances are in good order and can withstand setbacks.

Dividend History

While this background information is interesting and the company had a good year financially, the real reason we are interested in Stryker is the dividend and the dividend growth. We recently discussed Stryker's dividend history here, but it bears repeating. Stryker has raised their dividend each of the last twenty-three years. Investors in the company have gotten a raise in income every single year for almost a quarter of a century. The following table illustrates the company's dividend growth over a variety of time periods.

3-year dividend growth rate

17.50%

5-year dividend growth rate

18.10%

10-year dividend growth rate

31.30%

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While the dividend growth has slowed in recent years, the company has shown that they are dedicated to rewarding shareholders with double-digit raises each year.

Our Price Target

To help us find a good price target, we use the following analyst valuations: S&P Capital twelve-month price target and current fair value as well as Morningstar's current fair value. We then take the average of these three numbers and compare to the current trading price of a stock.

Sector

Current Yield

# yrs div growth

5 yrs div growth rate

Medical Devices

1.55%

23

18.10%

S&P Cap 12-month Price Target

S&P Cap Fair Value

Morningstar Fair Value

Our Price Target

$104

$101

$110

$98

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By our selection criteria, which you can see here, Stryker would be considered a Supporting Holding. While the company does have the minimum numbers of years of dividend growth to be a Core Holding, it does not meet the 2.0% yield threshold required for these types of positions. Therefore, we would require at least a 5% discount to our fair value average for purchase. Stryker closed on 2/10/2016 at a price of $98.10. At this price, Stryker is 7% undervalued by our criteria, which would qualify the company for purchase.

Conclusion

We don't currently hold Stryker in our portfolio, but it is near the top of our watch list. The company is a two years away from being a Dividend Champion and a dominant player in its sector of the economy. This is exactly the type of company we want in our portfolio. Stryker is trading right at our price target so as funds become available, we may initiate a position.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SYK over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.