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Stryker Remains Neutral

Zacks Equity Research

We reaffirm our Neutral recommendation on Stryker Corp. (SYK). Stryker reported second quarter 2012 adjusted earnings of 98 cents per share, in line with the Zacks Consensus Estimate and surpassing the year-ago earnings of 90 cents per share. Profits increased 4.8% year over year to $325 million (or 85 cents a share), led by higher domestic sales and margin expansion.  

Revenues were up 2.9% (up 5% in terms of constant currency) year over year to $2,106 million, but fell short of the Zacks Consensus Estimate of $2,129 million. Revenues were driven by healthy sales across its three segments in the U.S., partially offset by a weak European economy and currency fluctuations.

Stryker keeps introducing new products in the market at regular intervals. The company recently unveiled the next-generation Accolade Primary Hip Stem (Accolade II). This system is a notch above the company’s leading Accolade cement-less stem and is already on track to boost the Reconstructive business.

In addition, the Endoscopy division recently launched the 1488 High-Definition Camera with greater picture clarity which is expected to benefit surgeons during minimally invasive procedures.

Stryker continues to achieve healthy revenues, fueled by positive growth across all three segments of the company’s U.S. franchises. The Neurotech business is posting strong results on the back of Orthovita and Concentric acquisitions. The MedSurg division continues its healthy growth momentum, triggered by the Ascent acquisition and sustained growth across itsInstruments and Sustainability Solutions business.

Most importantly, in the Orthopedic Reconstructive division, domestic Hips, Knees and Trauma and Extremities sales have started showing signs of improvement with Trauma gaining significant grounds led by acquisitions.

However, the company’s mainstay, the Reconstructive business is facing pricing pressure and losing market share due to uncertainties prevailing in Europe.

Apart from macroeconomic headwinds, internal shortcomings related to executing organizational changes within the business have been hampering the business for quite some time now. Stryker needs to stay focused and stay on top and execute these changes before a combination of both external and internal issues start affecting the business adversely.

Recently, Stryker globally recalled the Rejuvenate and the ABG II Modular hip stem due to some product defaults which caused adverse local tissue reactions. This has resulted in a higher inventory which negatively impacted gross margin in the second quarter of 2012. Similar product recalls in future will negatively impact the company’s bottom line.   

Stryker operates in a highly competitive industry and faces strong competition from players like Zimmer (ZMH), Johnson & Johnson’s (JNJ) DePuy and Smith & Nephew (SNN). Moreover, the strengthening U.S. dollar, against the weak Euro and to some extent the Japanese Yen, is affecting the company’s international revenues.

Although the company did not change its guidance, it anticipates that the negative impact of foreign currency on net sales will be higher, given the euro volatility.

Our long-term Neutral recommendation on Stryker is in agreement with the short-term Zacks #3 Rank (Hold).

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