Stryker Corporation (SYK, Financial) has long been one of my favorite health care names as the company provides some market-leading medical devices.
Like many in its industry, Stryker experienced a difficult 2020 as the Covid-19 pandemic led to the cancellation of numerous elective medical procedures as health care systems around the world tried to contend with the virus.
Now that vaccine rollouts have been implemented in most countries, health care systems aren’t as stressed as they were, and most regions have lifted pandemic restrictions, resulting in elective procedures making a significant return.
Stryker is already seeing this in its business, and despite supply chain issues and unfavorable currency exchange rates, the company is poised to see record adjusted earnings per share in 2022.
At the same time, shares of Stryker are trading at a sizeable discount to their historical average price-earnings ratio and their GF Value. Coupled with a long history of dividend growth, this should make Stryker an appealing value candidate in my opinion.
Earnings highlights
Stryker reported its second quarter earnings results on July 26. Revenue grew 4.7% to $4.5 billion, but missed Wall Street analysts’ estimates by $50 million. Adjusted earnings per share totaled $2.25, which matched the prior year’s result but was 3 cents below expectations.
Organic sales grew 6.1% for the quarter, driven by a 7.9% improvement in MedSurg and Neurotechnology. Orthopaedics and Spine grew 3.9%.
Growth in MedSurg and Neurotechnology was primarily driven by volume gains of close to 8%. This more than offset a 1.4% decline in pricing. Prices for Orthopedics and Spine were lower by 3.2% year-over-year, but volume grew 7.1%.
Currency was a headwind during the quarter, reducing sales by 3%. Supply chain issues were also a negative factor for the company, especially when it came to electronic components. Limits on these materials, as well as staffing shortages at hospitals, limited acute care and emergency care business units.
The adjusted gross margin declined 270 basis points to 63.3%, largely due to higher input costs and supply shortages.
Stryker also provided an outlook for the rest of 2022. The company now projects organic growth of 8% to 9% for the year, up from 6% to 8% previously. Adjusted earnings per share are now seen in a range of $9.30 to $9.50, down from prior guidance of $9.60 to $10.00. At the new midpoint, adjusted earnings per share would be a 3.4% improvement from the prior year.
Takeaways
Revenue totals came in slightly less than expected, but Stryker saw solid organic growth in both of its businesses. This comes on top of last year’s 9.3% company-wide organic growth, which included mid-single-digit to mid-double-digit improvement in all areas of the company. Importantly, volumes are now largely back to pre-pandemic levels.
Strength was seen throughout product lines. Mako, Stryker’s surgical robot, had installation growth of 19%, and the number of procedures continue to recover from the pandemic. Hip and knees, two important growth areas for the company, were both up high-single-digits overall and close to 5% in the U.S., driven by an increase in procedures as well as new product launches. Endoscopy, instruments and neurocranial all had at least double-digit growth. Power tools, irrigation, smoke evacuation and Steri-Shield also performed well.
By regions, U.S. organic growth was up 4.7% while international improved almost 10%. Covid-19 lockdowns impacted China and Australia during the quarter, but Canada, Japan and Europe did away with most Covid precautions. These results show that the Stryker is still susceptible to declines where Covid-19 restrictions were in place, but growth was more than evident in regions where the virus was allowed free reign.
Stryker, never a company to shy away from making acquisitions, has already seen the benefits of its $3.1 billion purchase of Vocera Communications. Completed on Feb. 23, Vocera's expertise in digital care coordination and communication will compliment Stryker’s digital care business. Revenue for this segment has grown by double-digits in each of the last two quarters.
Gross margin declines weren’t terribly surprising given the shortage of raw materials and higher costs. For example, Stryker had to pay premium prices for electronic components given their scarcity in the market. Labor and transportations costs were also up compared to the prior-year period. The company does expect the adjusted gross margin to be stable for the third quarter, improve for the fourth quarter and decline approximately 200 basis points for the full year in comparison to 2021.
Leadership did say on the conference call that supply chain issues were beginning to improve and that constraints were beginning to ease to the point where businesses were likely to be less impacted by material shortages in the second half of 2022. Medical, in particular, should see an improvement in volume.
The upward revision of organic growth estimates was a positive to see, especially following results for 2021, where organic growth was higher by 12.6%. Guidance for earnings per share was reduced, but most of this was due to a more negative impact from currency exchange rates and not weakness in the business. Currency is projected to reduce earnings per share by 25 to 30 cents, which is up from the 10 to 15 cents guidance the company gave following the first quarter. From organic growth guidance and results throughout the company, demand for products has clearly resumed for Stryker.
Valuation analysis
Stryker closed Wednesday’s trading session at $212.50, implying a forward price-earnings ratio of 22.6 using the midpoint of company guidance. This is a discount to the 10-year average price-earnings ratio of nearly 26, according to Value Line.
Stryker also looks undervalued using the GF Value chart:
With a GF Value of $268.31, the stock has a price-to-GF-Value ratio of 0.79. Reaching the GF Value would result in a return of more than 26% from current levels. Add in the dividend and total returns could extend into the upper 20% range. Shares are rated as modestly undervalued.
The GF Score is strong at 91 out 100, with Stryker ranking high on growth, profitability and GF Value but disappointing on financial strength and momentum.
Final thoughts
Stryker’s most recent earnings results may have missed estimates by a small amount, but the company is seeing solid growth in almost all of its businesses. Currency exchange rates remain a concern, as do supply chain constraints, but the latter is at least starting to abate.
The company did lower earnings guidance for the year, but Stryker should still see positive growth compared to the previous year. On the other hand, organic growth forecasts were raised, showing that Stryker’s products remain in high demand.
Shares appear inexpensive on both a historical and GF Value basis. The stock’s dividend yield of 1.3% isn’t all that exciting, but Stryker’s dividend growth streak of 28 years and 10-year compound annual growth rate of 12.1% don't hurt.
