Stryker Misses Estimate, Profits Up

Zacks

Stryker Corp.’s (SYK) third quarter 2012 adjusted earnings of 97 cents per share missed the Zacks Consensus Estimate by a penny but surpassed the year-ago earnings of 91 cents per share (up 6.6%).

Adjusted earnings exclude restructuring expenses of $11 million associated with workforce reduction and other restructuring activities undertaken by the company in 2011 as well as integration and acquisition-related expenses of $6 million.

In the reported quarter, profits increased 8% year over year to $353 million (or 92 cents a share), primarily led by higher domestic sales and cost containment.

Revenue

Revenues inched up 1% (up 2.9% in terms of constant currency) year over year to $2,052 million, but fell short of the Zacks Consensus Estimate of $2,070 million. Revenues increased on the back of healthy sales across all U.S. franchises (except Medical) but were largely offset by weak international and capital equipment sales.

Acquisitions contributed only 0.4% while higher volumes along with improved product mix contributed 3.4% to total sales growth. However, currency rates and fluctuating prices negatively impacted revenues by 1.4% and 0.9%, respectively. Excluding the impact of acquisitions, revenues increased 2.5% year over year in constant currency.

On a geographic basis, revenues in the U.S. grew 4.7% to $1,360 million but sales in international markets dropped 5.6% (down 0.4% in constant currency) to $692 million.

Segments Analysis

Revenues from the core Reconstructive business (43% of total sales) inched down 1.1% (up 1.1% in constant currency) to $891 million. Except the impact of acquisitions, revenues from this segment increased 1% year over year in constant currency. The quarter witnessed strong U.S. Trauma sales and mid-single digit growth in the U.S. Knees business. This was, however, offset by pricing pressure and soft international sales in Europe and Japan.

Within Reconstructive, sales (as reported) from Hips dropped 3.9% (down 2.1% in constant currency) to $288 million, reflecting tough year-over-year comparables and negative impact from the Rejuvenate recall. Trauma and Extremities business dipped 0.7% (up 2.7% in constant currency) to $235 million. However, revenues from Knees business increased 1.4% (up 3% in constant currency) to $315 million, driven by the Get Around Knee Direct-to-Consumer campaign.

MedSurg sales (38% of total sales) grew 1.7% (up 3.1% in constant currency) to $781 million in the quarter, supported by gains from Sustainability Solutions and Instruments sales.

Within MedSurg, the 3% growth in Instruments sales to $303 million was partially dampened by the Neptune recall. Endoscopy sales inched up 1.1% to $259 million. However, Medical segment revenues fell 1.3% to $169 million due to soft capital equipment sales. Stryker expects continued growth in Instruments and Sustainability Solutions along with new products from the Endoscopy segment to boost future growth.
 
Stryker’s Neurotechnology and Spine business (19% of total sales) grew 4.7% (up 6.9% in constant currency) to $380 million. Barring acquisitions, sales from this segment increased 4.7% in constant currency. Sales were primarily driven by the Orthovita and Concentric acquisitions and new product launches, which offset the weak results of the core Spine business.

Sales from the Neurotechnology sub-segment jumped 10.8% to $205 million, partially offset by Spine sales, which fell 1.6% year over year to $175. However, soft spinal implant sales continue to dampen profits.

Margins

Gross margin climbed up to 68.1% in the reported quarter from 67.1% a year ago. Operating margin remained flat at 21.9%. Selling, general and administrative expenses were 38.5% of sales, compared with 37.7% a year ago. Research and development expenses, as a percentage of sales, dropped to 5.6% from 6% in the year-ago quarter.

Balance Sheet and Others

Stryker exited the quarter with cash and cash equivalents and marketable securities of $3,863 million, up 20.2%. Long-term debt roughly remained flat at $1,751 million.

In the quarter, Stryker repurchased roughly 0.4 million shares for $19 million.

Guidance

Stryker lowered its sales guidance for 2012 and 2013 due to the austerity measures in Europe and tough hospital capital budgets. In terms of constant currency, the company narrowed its revenues forecast, and expects revenues to increase in the range of 4% to 5.5% (earlier 3.5% to 6.5%). Excluding the impact of acquisitions, the company expects revenue to increase in a band of 2.5% and 4% (earlier 2% to 5%).

Stryker expects adjusted earnings for 2012 to be in the range of $4.04—$4.07 (up 9%). Earlier the company had expected adjusted earnings to grow at double-digit levels for 2012. For 2013, Stryker expects adjusted earnings in to be the band of $4.25 and $4.40.

Stryker also revised its forecast regarding the negative impact of foreign currency (assuming current exchange rates) on net sales for the full year and expects it to unfavorably impact sales by roughly 0.5% to 1.5% (earlier it was 1%–2%). For the fourth-quarter of 2012, the company expects an adverse impact of 0% to 1%.

Our View

Our ‘Neutral’ recommendation on Stryker carries a short-term Zacks #3 Rank (Hold). With a market-cap of $20.10 billion, Stryker is one of the world’s largest medical device companies operating in the global orthopedic market. Despite a soft orthopedic market and Medsurg end-market pressure, the company’s well-diversified product portfolio along with solid business fundamentals is expected to drive future growth.

Further, expansion into fast-growing international markets via strategic acquisitions and new product launches represent attractive growth opportunities. Moreover, the company remains committed to delivering incremental returns to investors leveraging its solid balance sheet, healthy free cash flow and earnings power.

However, Stryker faces several challenges, which include still soft international sales, tough hospital capital budgets and the upcoming Med-tech tax. Moreover, despite recent stability in the domestic market, it remains challenged by currency fluctuations and pricing pressure.

Weakness in the reconstructive and Medical businesses as well as soft spine sales continue to be a drag on Stryker. Additionally, Stryker operates in the highly competitive orthopedic industry and faces strong competition from players like Zimmer Holdings Inc. (ZMH).
 

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