As health care goes, the orthopedics sector isn't exactly burning down the house. As far as sex appeal and stunning growth prospects, it's got nothing on biotech or even the big drugmakers. What it
going for it is dependability -- and that's the case with
, a leading orthopedics outfit.
Stryker's primary business is making implants to replace defective hip and knee joints in aging people. That may not sound too exciting, but it's the engine behind some pretty strong growth numbers: Stryker expects earnings growth of 20% over the next few years, the result of favorable secular trends and operational improvements in efficiency and customer service.
That friendly 20% earnings estimate holds true for this year as well -- Stryker's business, focused as it is on health care, is relatively insulated from economic ups and downs. In fact, some analysts expect earnings to grow even faster this year, since the company could pick up market share from a stumbling competitor,
, which recently issued a recall on faulty hip replacements.
In any case, investors say Stryker offers the best record of bottom-line growth among its competitors. In its 2000 annual report, the company boasted that it has delivered 20% or better net earnings growth for more than 21 years until it chose to take on debt for an acquisition in 1998. Now, it says, profits are on track again. "I think they have a very astute management team that's run the company very consistently for 20 years," says Linda Miller, manager of the
John Hancock Health Sciences fund. In the orthopedic field, she says, "they have one of the best long-term track records in revenue growth, earnings growth and return to shareholders."
Stryker has been rewarded for that consistency: over a five-year period, the stock gained an annualized 36.3%, besting the S&P 500 by an average of 21.5 percentage points a year and other medical equipment companies by 15.3 percentage points.
Strong double-digit earnings growth carries a premium in the current market, but therein lies the stock's biggest downside: a pricey valuation. It's already shot up 55% in the last year, and even the rosiest price targets expect upside of only about 15%, or at a stretch, 20%.
Money manager David Jordan of
First Omaha Growth fund says he's pared back a little on Stryker since buying it a year ago because he thought it had gotten expensive. He's held on to some of the stock, though. "It's one of those kind of long-term above-average growers," he says.
Other money managers view occasional price dips as a chance to bulk up their holdings. When Stryker lost a little steam after the
Food and Drug Administration
nixed approval on a new biotech product in late January, Hancock's Miller viewed it as a good time to add to her holdings, rather than as a setback for the company. "Eventually the product will be on the market in some form," she says, "but investors should view that as the icing on the cake rather than the cake. You just have to watch for opportunities to buy the stock."
High Barriers to Entry
For Miller, like most investors, Stryker's appeal lies in its orthopedic implants business. Miller likes that market, she says, "because there's a very strong proprietary position companies can strike, and there's a real learning curve
for doctors in understanding and implementing their products." For that reason, there tend to be high barriers to entry in the orthopedics business. Doctors expect a high degree of quality and customer service in implant devices that will, after all, end up inside their patients.
And physicians have regained some of the decision-making power that they lost to penny-pinching HMOs and group buyers in the 1990s. That bodes well for the sale of higher-end and more expensive orthopedic devices.
Stryker draws over half of its revenue from orthopedic implants. Sales of the devices are expected to grow at a slow but steady clip of 5% to 6% a year, supported by demand from a growing and increasingly active elderly population.
Companywide, revenue should grow this year by about 8%, according to a
estimate. The higher overall gains are expected to follow from more rapid growth in secondary business lines focused on surgical instruments and endoscopy, which together contribute over a third of revenue, as well as physiotherapy, which makes up only about 7% of sales. But investors tend to view Stryker's well-run implants business as the main reason to own the stock.
The company has also made some operational gains integrating a huge acquisition it made two years ago. In a move that doubled its size and greatly increased its overseas reach, Stryker bought
, a Pfizer subsidiary, in 1998 for $1.9 billion in cash. "When they acquired Howmedica," says
analyst Sandra Hollenhorst, "they needed to rationalize all the manufacturing between the two companies and rationalize the product line. They've done a nice job of getting that under control, regaining the confidence of their sales force."
A byproduct of that confidence is that their salespeople are less likely to over-order supplies, she says, which will have the effect of keeping down inventory levels. Stryker trimmed inventory back orders from $6.2 million in the fourth quarter of 1999 to a little over $200,000 in the last quarter of 2000.
Aiming to boost efficiency and complete the integration of Howmedica, Stryker consolidated more than a dozen production facilities into one New Jersey campus last year.
Growth in Foreign Markets
In the wake of the acquisition, Stryker draws 42% of its sales from outside the U.S., according to Morningstar. Investors view that exposure as a long-term advantage, since aging populations in Japan and Europe should drive demand for the company's products.
Recently analysts have also been pleased by a turnaround in European operations, which not long ago were viewed as a drag on returns. For 2001, Stryker's management expects market gains there. Several new products will launch in Europe this year, and in a bid to encourage a more aggressive approach to sales, the sales force will begin operating on a 100% commission basis, as it does in the U.S.
On the downside, currency fluctuations overseas stand to cut into Stryker's profits. Japan alone contributes 12% of revenue and 20% of earnings, and this year revenue there could take a hit from the weak yen.
A less positive legacy of the acquisition is Stryker's sizable debt load. At the end of 2000, the company owed about $1.14 billion stemming from the purchase of Howmedica.
"The company does have a fair amount of debt," acknowledges Miller. "But they're paying it down at ever-increasing rates, and they have good cash flow to do that." Last year the company paid down $245 million in debt ahead of schedule, well above its goal of $150 million.
The bottom line: Stryker probably doesn't hold out lots of upside at its current levels. But it may offer a good value on price dips for investors who like the idea of 20% earnings growth prospects without undue risk.
"I don't think people looking for accelerating earnings stories, big surprises on the upside, will find it here," says Miller. "But that's the way its shareholders like it. Stryker's one of the better no-surprise stories out there."