Concerned about the end of the market cycle and not willing to trade short term, I’ve been waiting for buying opportunities and not doing much in my personal portfolio. Earlier this month, however, a stock in one of my favoured sectors sold off and became too attractive to skip.
Shares of medical technologies company Stryker Corp. (SYK-NYSE) climbed 3.2 per cent after reporting strong earnings on Oct. 29, but the stock fell almost 10 per cent on Nov. 4 after announcing a major acquisition. I bought the stock on weakness for the following four reasons.
Performance: Returns on Stryker’s stock have crushed the broader health-care sector and the S&P 500 over the past five years. Stryker’s total return for the period of 144 per cent (19.6 per cent annualized) easily outdistanced the S&P 500 Health Care Index’s 53.3-per-cent return (8.9 per cent) and the S&P 500’s 68.2 per cent (11 per cent).
Diversification: Kalamazoo, Mich.-based Stryker’s numerous businesses fall under three broad categories. Orthopedics covers knee- and hip-replacement systems as well as treatment of bone trauma; medical and surgical includes endoscopy equipment and surgical equipment; and neurotechnology and spine is the third large category.
Guggenheim Partners analyst Chris Pasquale, in a recent report, outlined how the broad nature of the company’s profit-generating operations benefits investors. Stryker’s seven different sub-businesses each contribute more than 10 per cent of overall revenue in 2018, with no one franchise responsible for more than 16 per cent, he noted. This model “insulates Stryker from temporary weakness in any one segment," he said.
Growth: An aging developed-world population is creating a strong growth tailwind for health-care demand, particularly within the orthopedics business. In 2018, for example, the more than 58,000 hip-replacement surgeries done in Canada represented a 17.4-per-cent increase from 2013, according to the Canadian Institute for Health Information.
For Stryker, the most recent quarterly results indicated an 8.9-per-cent annual increase in knee-replacement revenue and a 7-per-cent increase in hip-surgery revenue.
Demographic forces benefit all of Stryker’s health-care businesses, driving expectations for revenue growth in 2020 of between 7 per cent and 8 per cent. JPMorgan analyst Robbie Marcus noted that this is well above the peer group average of 5 per cent and makes Stryker “one of the premium growth stories in the MedTech universe."
Robotics: In 2013, Stryker acquired Mako Surgical Corp. for US$1.7-billion. Mako had developed a robot-assisted process for knee and hip replacement and Stryker’s recent success in expanding its orthopedics revenues owes a lot to the growing popularity of Mako.
Morgan Stanley analyst David Lewis calculated that Stryker’s 7.3-per-cent growth in orthopedics revenue – 1.5 per cent ahead of his earlier estimates – was driven by Mako, and believes that sales momentum continues to build. The Mako system was recently approved in Japan and management hopes to get permission to sell the process in China in 2020.
Final words of caution
Science has yet to find a way to reverse the aging process, so demand for joint replacements and health care generally is almost certain to climb, to the benefit of profits for companies such as Stryker in related businesses.
This does not, however, imply that there are no risks to my new investment.
This month’s downdraft in the stock price was caused by the announcement of Stryker’s US$4-billion buyout of Wright Medical Group NV – a company with a dominant position in ankle-replacement systems. I am hopeful that because the company has a history of successful acquisitions (such as Mako), the new operation can be efficiently integrated into the larger company.
The higher expected corporate debt levels the deal will create led to Moody’s and Standard & Poor’s putting Stryker on its review list and a potential credit downgrade is a near-term investment risk.
U.S. government and U.S. insurer policy changes are also a threat to shareholders. Stryker has expanded worldwide, but changes in U.S. reimbursement policies would reduce future profits. Stryker also faces a competitive landscape featuring orthopedic giants such as Warsaw, Ind.-based Zimmer Biomet Holdings Inc., which is also a risk.
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