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Stryker Has a Bounce-Back Quarter

GuruFocus.com
·7 min read

- By Nathan Parsh

Shares of Stryker Corp. (NYSE:SYK) are up 10.5% in 2020, but almost the entirety of that gain has been since the company reported earnings results at the end of October. Covid-19 has negatively impacted the company's operations for much of the year as elective surgeries were delayed due to the stress on the health care system. We took advantage of the weakness in Stryker and added to our position in July at around $190.


Now some of that strain has been reduced and the company has seen a pickup in procedures. Is that enough to warrant buying shares of Stryker?

Quarterly highlights

Stryker announced earnings results for the third quarter on Oct. 29. The company's adjusted earnings per share increased 23 cents, or 12%, to $2.14 from the previous year. This was 71 cents above what Wall Street analysts had expected. Revenue of $3.7 billion was a 4.2% improvement year over year and $327 above estimates.

Organic growth improved 3.3% for the quarter. This was below organic growth of 8.6% for the same quarter a year ago, but a significant improvement from a 24% decline that Stryker saw in the second quarter of this year.

Management said on the conference call that is experienced a V-shaped recovery in its businesses. Results in the second quarter were down considerably as the Covid-19 pandemic really limited procedures. That pressure subsided somewhat in the most recent quarter and demand for Stryker's products rebounded sharply.

U.S. sales were up 3.5%, with international growing 2.8%. Regions seeing the strongest recovery were the U.S., Australia, Germany and Canada. The U.K. and India remain weak.

Each segment of the company posted positive organic growth rates. Unit volumes company-wide were up 4.7%, more than offsetting a 1.4% decline in pricing.

Orthopaedics organic growth improved 3.8% as volumes were up 5.9%. Lower realized prices of 2.1% partially offset this gain. U.S. sales improved 7.5%. Demand in the areas of knee, hip, trauma, extremity and sports medicine were up compared to the previous year. International was down 4.7% due to a slower recovery in elective procedures in Europe.

Mako procedures increased 30% year-over-year. Stryker installed its 1,000th Mako robot during the quarter. Knee and hip replacements, the two most common joint procedures, are expected to grow a total of 401% and 284%, respectively, through 2040 off of last year's numbers. As more surgeons and patients become comfortable with a robot, it is likely that Mako's share of this expanding market will continue to grow.

Organic growth for MedSurg was higher by 2.5%. Unit volumes climbed 3.1%, but were partially offset by a 0.6% decrease in pricing. The segment had higher customer demand for safety-related products, such as waste management and smoke evacuation. Endoscopy inched higher by 1% as double-digit growth in sports medicine was offset by core endoscopy and communications businesses. Emergency care also grew at a high rate. International organic growth was up almost 7% due to improvements in nearly every product category across all major regions.

Neurotechnology and Spine led the way with a 4.3% increase in organic growth. Unit volumes were up 6% with lower prices reducing results by 1.7%. Stryker saw improvements in the areas of spine, brain and neurovascular businesses. The company's ischemia product line, which is used to increase blood flow and oxygen to the heart muscle, grew by double digits. Outside of the U.S., this segment had almost 10% organic growth due to increased demand for hemorrhagic, ischemic and spine products.

Adjusted gross margins improved 20 basis points to 65.9% due to an improvement in volume and mix. Expenses were well managed as selling, general and administrative costs were down 210 basis points to 31.7%. The company does expect costs to increase in future quarters as a ramp up in business to normalized levels will require additional hiring and discretionary expenses. Stryker ended the quarter with $7.2 billion in cash and securities, including $5 billion from the closing of the Wright Medical Group acquisition.

Stryker did not reinstate guidance for 2020 due to the uncertainty regarding Covid-19, but analysts surveyed by Yahoo Finance expect an average of $7.19 of earnings per share for the year. While this would be a decline of 13% from the previous year, it is better than analysts' previous consensus estimates of $6.36 following the second quarter. In fact, all 24 analysts following the company raised earnings expectations following the third-quarter report according to Seeking Alpha.

Looking at the previous year, Stryker's fourth quarter tends to be the company's strongest. For example, fourth-quarter earnings per share and revenue totals have been the highest totals for the year since at least 2016.

Given the rebound seen in the third quarter, it is likely that the fourth quarter will show at least some modest growth compared to the previous year. Earnings per share for the fourth quarter would have to increase just 3.2% from last year's results to give Stryker $7.19 in earnings for the year.

Unless Covid-19 again leads to a shutdown in elective procedures, it is my belief that Stryker is highly likely to produce bottom-line results above what analysts are looking for as the improvements experienced in the most recent quarter extend to the end of the year.

Valuation

If there is a quibble with Stryker, it's the stock's valuation. Based on Friday's closing price of $231.94 and expected earnings per share, the stock has a forward price-earnings ratio of 32.3.

According to Value Line, Stryker has an average price-earnings ratio of 25.2 and 23.4 over the last five and 10 years, respectively. Shares of the company have traded with an elevated valuation recently, but nowhere near the current multiple.

However, Stryker has been significantly impacted by Covid-19. The company had expected earnings per share of $9.10 for the year before the pandemic severely restricted elective procedures. Consensus estimates for next year call for $9.06 as analysts believe that Covid-19 is likely to be less impactful to Stryker's results. The company currently trades at 25.6 times next year's earnings estimates. This is higher, but much closer to the stock's average valuations over the medium and long term.

GuruFocus finds that Stryker is trading higher than its intrinsic value.

Stryker Has a Bounce-Back Quarter
Stryker Has a Bounce-Back Quarter

GuruFocus gives Stryker a GF Value of $191.68. Using the most recent closing price, Stryker has a price-to-GF Value of 1.21. This ratio earns Stryker a rating of modestly overvalued from GuruFocus. Reverting to this level would result in a price decline of 17.4%.

Final thoughts

Stryker's most recent quarter was a massive improvement from the previous quarter. Each of the company's segments and most of the business lines rebounded as elective procedures were allowed to be conducted in most major markets.

However, earnings per share for the year will likely be down double digits from the previous year, making the stock look extremely expensive today. Using estimates for next year's numbers puts the stock as only slightly overvalued. Shares also score decently using the GF Value.

Stryker yields just 1%, but the company has raised its dividend for 27 consecutive years.

In the long run, Stryker has proven that its products remain in high demand. Aging demographics should also be a tailwind to the company, especially in the area of knee and hip replacements.

The company's valuation is rich, but due largely to forces outside of its control. Further out, the multiple looks less expensive, but remains above its long-term average.

While the company truly had a nice bounce back quarter, we feel that shares have gotten a little ahead of themselves. On a pullback, we would be happy to add to our position in Stryker.

Disclosure: The author maintains a long position in Stryker.

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This article first appeared on GuruFocus.