Pricey Stryker Needs a Deal to Spur Healthy Growth

NEW YORK (TheStreet) -- Medical device giant Stryker (SYK) has rewarded investors with year-to-date gains of close to 12%. On its own, that's not a breathtaking number. But when compared to the 7% gain of the medical devices sector, according to Morningstar, it's tough to complain.

It's also tough to argue against how expensive these shares have gotten. Currently, they trade around $83.50.

This now pushes Stryker's price to price-to-earnings ratio past 41. That's 13 points higher than the industry average P/E of 28, according to Yahoo! Finance.

Investors can have both St. Jude Medical (STJ) and Medtronic (MDT) at much cheaper multiples of 25 and 21, respectively. St. Jude and Medtronic both outperform Stryker in gross margin and operating margin.

While the company has done a decent job addressing a wider range of markets within medical technology, the company reconstructive business continues to struggle, growing just 2.5% in the most recent quarter and trailing the likes of Johnson & Johnson (JNJ) , up 3%, and Biomet, which reported 4% in its most recent report before its pending acquisition.

Johnson & Johnson trades at a P/E that is 22 points lower and pays a 2.80% dividend compared to a 1.50% yield for Stryker. Even if we were to use the "investors are paying for growth" argument, Stryker would still be at a deficit to Johnson & Johnson, which is growing a 9% rate compared to 7% for Stryker.

So where's the value?

At a P/E that almost doubles the industry rate, Stryker should -- at least -- post double-digit revenue growth. To that end, it makes sense for Stryker to seek growth through a merger or an outright acquisition. It's one of the ways that companies with tons of cash but short on growth can have instant access new revenue and markets that would have taken years to build.

Medtronic's $42.9 billion deal for Covidien (COV) is one of several recent examples of med-tech M&A that has occurred as companies look to grow and, in some cases, diversify their offerings. Zimmer Holdings (ZMH) wasted no time buying orthopedic device maker Biomet for $13 billion.

For Stryker, it would immediately become a med-tech power by picking off Smith & Nephew (SNN) . Stryker can then leverage its strong research and development capabilities to dominate areas like hip and knee replacements. Combined with Smith & Nephew, Stryker would command more than 30% of that market.

With that kind of clout and market leverage, hospitals that specialize in joint reconstruction would have no choice but to accept Stryker's price points. Stryker can't waste time, however, especially with Medtronic and Covidien coming together -- and a company such as Johnson & Johnson may have Smith & Nephew on it radar already.

Until then, with the shares carrying a premium valuation, investors are paying for the work that Stryker's management has already done. Stryker needs new growth and a new set of offerings that allows it to differentiate from peers that are trading at a much lower multiple.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.


TheStreet Ratings team rates STRYKER CORP as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate STRYKER CORP (SYK) a BUY. This is driven by several positive factors, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, good cash flow from operations, expanding profit margins and solid stock price performance. We feel these strengths outweigh the fact that the company has had sub par growth in net income." You can view the full analysis from the report here: SYK Ratings Report

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