Stryker Beats but Concerns Linger - Analyst Blog

Orthopedic devices major Stryker Corporation (SYK) reported better-than-expected fourth-quarter fiscal 2010 results with adjusted earnings per share of 93 cents exceeding the Zacks Consensus Estimate of 90 cents and the year-ago earnings of 82 cents.

For fiscal 2010, adjusted earnings of $3.33 per share beat the Zacks Consensus Estimate of $3.31 and was ahead of the year-ago earnings of $2.95. The results were supported by higher sales owing to strong contribution from the Michigan-based company's surgical equipment business.

The adjusted earnings exclude the charges associated with the company's divestiture of its bone growth product franchise (the “OP-1” product line) to Tokyo-based equipment maker Olympus Corporation. Stryker recorded an impairment charge of roughly $124 million ($77 million net of tax) in the fourth quarter to reflect an anticipated loss in connection with the transaction. 

Adjusted net income for the fourth quarter and fiscal year climbed 12.5% and 12.6% year over year, respectively, to $372 million and $1,329 million. However, on a reported basis, profit for the quarter clipped 3.6% to $295 million (or 74 cents a share) on account of the hefty impairment charge and higher expenses.

Despite the forecast-beating earnings and a healthy outlook, Stryker's shares fell 87 cents (or 1.49%) to $57.50 in after-hours trading on October 25, mostly reflecting the concerns over pricing pressure in the orthopedic business and the lower fourth quarter profit.

Results in Detail

Revenues

Revenues for the quarter climbed 8.8% year over year to $1,995 million, ahead of the Zacks Consensus Estimate of $1,987 million. For the full year, sales rose 8.9% to $7,320 million, edging past the Zacks Consensus Estimate of $7,313 million. Sales were boosted by healthy growth in Stryker's domestic revenues. 

Segment Analysis

Global Orthopaedic Implants sales grew 4.5% in the fourth quarter to $1,166 million, reflecting some recovery in this business after a meager third quarter growth of 1.2%. Stryker's hips, knees and trauma businesses posted growth in the quarter while softness in its spine franchise lingers. The company achieved favorable traction for its new hip systems, Restoration ADM and Rejuvenate, in the quarter.

However, the orthopedic division remains affected by pricing pressure and soft procedure volume. The joint replacement market remains sluggish as patients defer their elective procedures given the lingering economic softness and high unemployment rate.

Stryker continues to experience pricing pressure for its hip and knee implants. One of its competitors, DePuy, a unit of Johnson and Johnson (JNJ), has echoed similar concerns. According to Stryker, company-wide selling prices dipped 2.1% globally in the quarter (down 1.7% in 2010).

The MedSurg division, Stryker's key growth engine, continued its double-digit growth momentum with revenues cruising 15.3% to $829 million. Growth was led by higher sales of surgical equipment and surgical navigation systems (up 10%), endoscopic and communications systems (up 5%), and patient handling and emergency medical equipment (up 21%). Acquisitions contributed 8% to the growth. Recovery in hospital spending represents a tailwind for this division.

Geographically, U.S. revenues (up 11%) contributed 64% of the total sales while International sales (up 5%) accounted for the balance. Domestic sales benefited from higher shipments of orthopedic implants and surgical equipment while international revenues were favorably impacted by foreign exchange translation.

Margin Trends

Gross margin for the quarter improved to 68.7% from 67.7% a year ago on the back of higher revenues. Research, development and engineering expenses as a percentage of sales increased to 5.6% from 4.9% a year ago. Selling, general and administrative expenses (as a percentage of sales) rose to 36.8% from 34.3%. Operating margins fell to 19.4% from 28% a year ago due to higher operating expenses (up 35%).

Financial Health

Stryker exited fiscal 2010 with cash and cash equivalents and marketable securities of $4,380 million, up 48% year over year, along with a long-term debt of $996.5 million. The company generated roughly $1,547 million of cash from operations during the year, up 6% year over year, including $518 million in the fourth quarter.

Stryker remains committed to delivering incremental returns to investors leveraging a solid balance sheet and healthy cash flow. The company repurchased 6.1 million shares worth $314 million in the fourth quarter, bringing the total repurchases to 8.3 million for fiscal 2010.

Outlook and Recommendation

Stryker has reaffirmed its fiscal 2011 outlook, released two weeks ago, with revenues expected to grow 11%-13% in constant currency on the back of higher shipments of Orthopaedic Implants and MedSurg Equipment coupled with the contribution from its recently acquired neurovascular business of Boston Scientific (BSX). The company expects foreign currency (assuming current exchange rates) to favorably impact sales by roughly 0%-1% in first-quarter 2011 and 0.5%-1.5% in full-year 2011.

Adjusted earnings for fiscal 2011 have been forecast in the range of $3.65 to $3.73 per share, representing a 10%-13% annualized growth. Adjusted earnings exclude charges associated with the acquisition of the neurovascular business, which the company expects would trim 2011 earnings per share by roughly 21 cents to 25 cents. The current Zacks Consensus Estimate for fiscal 2011 is $3.69.

We believe that Stryker remains well placed for growth across its Orthopedic and MedSurg units driven by new product launches, acquisitions and an improving hospital capital spending backdrop. The MedSurg division continues to grow at a healthy double-digit rate, benefiting from the synergies from the Ascent Healthcare acquisition. Moreover, new products including ADM and Rejuvenate are expected to favorably impact 2011 results.

However, Stryker faces stiff challenges from Zimmer Holdings (ZMH), Smith & Nephew (SNN), CONMED Corp (CNMD), Biomet and DePuy in a highly competitive orthopedic industry. Moreover, Stryker is exposed to pricing and volume pressure on its hip, knee and spine products and a still soft reconstructive implant market. We are currently Neutral on Stryker, backed by a short-term Zacks #3 Rank (Hold).

 
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