Although some companies may deserve bullish considerations on the basis on their own performances, some have to be assessed on a relative basis. That is to say, if company X is doing this, then company Y should be doing that.
Though this form of appraisal is not an exact science, it's nonetheless where Stryker is today -- fairly or unfairly.
Although Stryker undoubtedly has a strong position in the orthopedic and medical technology market, where it competes with (among others) Johnson & Johnson and Medtronic , Stryker's valuation has outpaced its performance. It's up 26% year to date. And on the heels of soft first-quarter numbers, it's time for the stock to take a pause.
Unassuming First Quarter
Prior to the company's first-quarter results, shares had already gained 20% on the year. Stryker needed to deliver (at least) in-line results to push the stock higher. Unfortunately, the overall performance fell a bit short. Revenue increased 1.3% to $2.19 billion, missing the Street's estimates by a slim margin.
There was also very little excitement in Stryker's segment performance as sales in the reconstructive device business grew just 1%, even though it was closer to 5% on an organic basis. Likewise, the surgical-products business continues to be sluggish as revenue was nearly flat. The company was able to offset this with a better-than-expected showing in its neurotechnology segment.
The company also posted decent gains in the spine business, which grew revenue 4% year over year. It's a solid performance. I do wonder, though, how long Stryker can rely solely on the strength of the spine and the neurotech businesses. Elsewhere, reconstructive devices were unimpressive. But Johnson & Johnson's performance in that business didn't overwhelm, either.
Although I'm willing to look the other way here and excuse the weakness in the reconstructive devices as a general market event, it still looks as if Stryker is losing share in that area to Johnson & Johnson. Profitability wasn't any better as Stryker posted a 13% decline in net income due to (among other things) a recall of the company's hip implants.
Remarkably, though, when adjusting out the charges related to the recalls, which amounted to $40 million, the company was able to beat Street estimates by 2 cents. For that matter, management deserved credit for the manner in which Stryker has handled margin pressure. Although this quarter saw a slight decline in gross margin, the result actually arrived better than expected.
Relative to expectations, Stryker's first-quarter performance was broadly positive. The across-the-board numbers didn't inspire the level of giddiness that Covidien's results generated. I was nonetheless pleased by the EPS beat given the situation that surrounds hip implants.
That said, this situation does bring about uncertainty regarding the share price. As with St. Jude Medical , which is dealing with regulatory scrutiny by the FDA regarding the safety of company's Durata Leads, Stryker has taken some precautionary measures to ensure the safety of its products, including ceasing worldwide distribution.
Although the recalls didn't show much adverse impact this quarter (on a relative basis), I'd like to see what the next quarter (and beyond) bring. Given the recent 20% gains in the stock, it would seem wise for investors to take some profits and wait for the next quarter. Instead, the Street has decided to "push its luck" with the valuation.
Not only is Stryker's P/E of 21 higher than the industry average of 20, but the fact that the shares are trading at 3 points and 4 points higher than Zimmer Holding and Covidien, respectively, suggest that the Street has already priced in outperformance. While Stryker is certainly improved, this is not a bet I'm willing to make -- at least not until there is more clarity about the recalls.
These issues notwithstanding, management still expects earnings to arrive in a range of $4.25 to $4.40; the high end of that range is 7 cents better than the average estimate. This does explain why investors feel confident that the recall situation will end favorably. But there's still too much excitement for growth that I would consider decent at best. Concerns about valuation aside, Stryker is still a solid medical technology company with an excellent management team. The stock's just too demanding at these levels.
At the time of publication, the author held no position in any of the stocks mentioned.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.