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Investors with a short-term mindset are likely to invest in companies that are the 'flavour of the day'. Long-term investors, however, look at a company's future potential and welcome instances when great companies fall out of favour and valuations retrace to reasonable levels. The COVID pandemic is creating ongoing nursing staffing shortages and is primarily impacting Stryker's (SYK) implant-related businesses (ie. hips, knees, spine, foot, and ankle); these surgeries can, in many cases, be deferred. In my opinion, Stryker's headwinds present a buying opportunity for investors who recognize that the growing global population will lead to a greater number of surgical procedures requiring SYK products and services.
I reviewed SYK in this November 22, 2021 post and included it in my 3 Great Growth Stocks For Long-Term Investors post.
SYK's ~$241 share price when I compose this post on January 28, is well off its 52 week high of ~$281. SYK has also released Q4 and FY2021 results on January 27. I now take this opportunity to revisit SYK.
Business Overview
In addition to my high-level overview in my November 22 post, I encourage investors to review SYK's website, Section 1 of the FY2020 10-K, and the 2021 Investor Day Presentation.
The surgical videos within the Surgical Video Library on SYK's website provide a good explanation of how SYK's products and services are used to enhance a patient's quality of life.
Acquisitions
In my November post, I touched upon some of SYK's acquisitions.
Profitable growth is a top priority. SYK's strong cash flow performance and debt reduction have positioned management to start looking at slightly larger tuck-in acquisitions in conjunction with ongoing debt reduction.
Despite valuations being very high overall, management has indicated there are still a lot of target companies. It remains confident that it will continue to find value-creating acquisition opportunities.
Thermedx Acquisition
In Q4 2021, SYK completed the relatively small Thermedx acquisition; Thermedx is an innovative developer and manufacturer of fluid management solutions and will allow SYK's endoscopy business to improve surgical visualization across the women's health segment and advance the standard of care in the urology segment.
Vocera Communications Acquisition
On January 6, 2022, SYK announced its agreement to acquire Vocera Communications, Inc. for a total equity value of ~$2.97B and a total enterprise value of ~$3.09B (including convertible notes). This acquisition is targeted to close in Q1 2022 and is expected to have a neutral impact on SYK's FY2022 net diluted EPS.
This acquisition represents SYK's entry into the fast-growing digital care coordination and communications segment.
Source: Acquisition of Vocera Presentation - January 6, 2022
Management is always actively looking at acquisitions despite its continued focus on debt reduction. Given the growth and debt reduction priorities, investors should expect an impact on either dividend increases or a reduction in shares outstanding.
Financials
Q4 and FY2021 Results
I reference SYK's Q4 and FY2021 results found in the Q4 2021 8-K. Given the variability throughout 2020, many FY2021 comparisons are made to FY2020 and FY2019 results with FY2019 results considered to be a more normal baseline.
SYK has reclassified its reporting segments into:
- MedSurg and Neurotechnology
- Orthopaedics and Spine.
to better align how the businesses are managed.
In addition, SYK has pulled out Neurovascular on its own line and the business units of neurosurgical instruments, CMF and ENT are now grouped under Neurocranial (refer to page 8 of 12 in the Form 8-K).
Organic sales growth exceeded 6% versus 2019, driven by double-digit growth from the MedSurg and Neurotechnology businesses. These strong results, however, were offset by softer sales of Hips, Knees and Spine as COVID and hospital staffing challenges had a meaningful impact on elective procedures.
SYK posted double-digit organic growth in international markets compared to 2019 as the company's globalization efforts continue to bear fruit and where COVID impacts were generally less severe than in the US.
Although SYK's more deferrable businesses were challenged, excellent results were generated from SYK's Mako robotic technology; SYK's global Mako installed base grew by 27% and the installed base is approaching 1,500 Mako robots.
Knee procedures: In Q4, over 50% of SYK's total knee procedures were Mako knee procedures. This is a trend that continues to increase and demonstrates the outstanding utilization of the Mako install base. The shift toward cementless knees also continued. In Q4, cementless knees made up 47% of SYK's U.S. knee procedures.
Hip procedures: In Q4, over 25% of SYK's total hip procedures were Mako Hip procedures.
SYK recently launched Insignia Hip Stem and this will be Mako-capable by the end of Q1.
In SYK's Trauma and Extremities business, SYK is now 1 year into the integration of Wright Medical. The integration is progressing well in all regions and across all functions despite the COVID headwinds.
Including Wright Medical, the combined US Trauma and Extremities business grew high single digits in 2021; this exceeded management's expectations. FY2021 growth in the US was driven by strong growth in core trauma and double-digit growth in the upper extremities business which offset the COVID-related impact on foot and ankle.
Free Cash Flow (FCF)
To measure earnings performance on a consistent and comparable basis, SYK excludes certain items that affect the comparability of operating results and the trend of earnings.
FCF is measured by adjusting cash provided by operating activities by the amount spent in the purchase of property, plant and equipment and proceeds from long-lived asset disposals. In addition, the impact of certain legal settlements and recall payments is removed. To measure free cash flow conversion, FCF is divided by adjusted net earnings to measure FCF conversion.
FY2022 Guidance
The COVID pandemic has and will continue to, negatively impacted SYK's performance. In the short-term, management views the outlook to be volatile.
Management does not expect to deliver the typical operating margin expansion as a result of the ongoing price escalation on supply-constrained raw materials like electronic components and rising inflationary costs on raw materials transportation and labour costs.
Because of the latest COVID wave and the current inflationary environment, SYK expects a negative 50 - 100 bps impact to gross margin with a more pronounced impact in the first half of FY2022. Plans are to return to the normal delivery of margin expansion in a post-COVID environment.
FY2022 organic net sales growth is expected to be 6% - 8% and the expected adjusted diluted EPS guidance is $9.60 - $10.00. This wider than normal guidance represents the ongoing variability in the operating environment.
- The upper end of the range assumes the latest COVID wave subsides in Q1 with no additional major COVID disruptions during the year. In addition, it assumes the supply chain stabilizes by the end of the first half of the year.
- The low end of guidance assumes the continued COVID-related volatility persists, including supply chain pressures that could impact revenues as well as costs and includes more transient spot buying and longer-term supply chain pressures.
SYK's FY2022 projection is ~$0.65B bearing in mind the target is 70% - 80% of FCF. Spending reductions have been made in several areas. Management, however, expects spending to pick up if the world returns to a more normal operating environment.
Credit Ratings
Immediately following the January 6, 2022 announcement of the proposed Vocera Communication acquisition, Moody's and S&P Global placed SYK's domestic senior unsecured long-term debt ratings under review with negative implications.
Current ratings are:
- Baa1 (Moody’s) is the top tier within the lower-medium grade category;
- A- (S&P) is the lowest tier within the upper-medium grade category.
The Baa1 rating defines SYK as having an ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.
The A- rating (one notch above the Baa1 rating) defines SYK as having a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
These ratings are satisfactory for my purposes. Even if these ratings are lowered one tier, SYK's credit ratings would still satisfy my risk tolerance.
Dividend and Dividend Yield
SYK has a track record of increasing dividends. The capital deployment priority, however, is M&A to drive sales growth in core and adjacent markets.
SYK will be distributing its 1st quarterly $0.695/share dividend. This is just a bit higher than the ~$0.04 - $0.06/share quarterly dividend increase I anticipated; the previous quarterly dividend was $0.63.
At the time of my November post, the dividend yield was ~1%. The dividend yield following the dividend increase and share price pullback to ~$241 is now ~1.15%.
The weighted-average diluted shares outstanding (in millions) in FY2011 - FY2021 is 390, 383, 382, 383, 381, 379, 380, 380, 380, 380.3 and 382.3 because of share-based compensation.
SYK discontinued the repurchase of outstanding shares in 2019 when it announced its intent to acquire Wright Medical. On the Q4 earnings call, management indicated there is no plan to do any share buybacks given the anticipated focus on further debt reduction.
Valuation
In FY2021, SYK reported $5.21 in diluted EPS. Using the current $241 share price, the valuation based on historical results is ~46.26.
In my November 22 post, I explained that investors need to consider that earnings are negatively impacted by the Amortization of Intangible Assets (a non-cash expense). I think investors should look at SYK's valuation based on adjusted earnings given the extent of various non-cash items.
SYK reported FY2021 adjusted EPS of $9.09. Using the current ~$241 share price, this is an adjusted PE of ~26.5. By way of comparison, SYK's adjusted diluted PE levels based on FY2015 - FY2020 adjusted diluted earnings are:
- FY2020: $7.43, ~$231, adjusted diluted PE ~31.1
- FY2019: $8.26, ~$214.90, adjusted diluted PE ~26
- FY2018: $7.31, ~$161, adjusted diluted PE ~22
- FY2017: $6.49, ~$168.75, adjusted diluted PE ~26
- FY2016: $5.80, ~$121.50, adjusted diluted PE ~21
- FY2015: $5.12, ~$96, adjusted diluted PE ~18.75
Management's FY2022 adjusted diluted EPS guidance is $9.60 - $10.00 for a current forward adjusted PE range of ~24 - ~25.
When I wrote my November 22 post, the projected adjusted diluted PE levels based on current FY2021 - FY2023 broker guidance were:
- FY2021 - 25 brokers - mean of $9.12 and low/high of $9.08 - $9.20. Using the mean, the forward adjusted diluted PE was ~29.
- FY2022 - 25 brokers - mean of $10.21 and low/high of $9.75 - $10.95. Using the mean, the forward adjusted diluted PE was ~26.
- FY2023 - 20 brokers - mean of $11.32 and low/high of $10.93 - $12.26. Using the mean, the forward adjusted diluted PE was ~23.3.
The projected adjusted diluted PE levels based on current guidance and a ~$241 share price are:
- FY2022 - 28 brokers - mean of $10.15 and low/high of $9.75 - $10.95. Using the mean, the forward adjusted diluted PE is ~23.7.
- FY2023 - 23 brokers - mean of $11.22 and low/high of $10.67 - $12.26. Using the mean, the forward adjusted diluted PE is ~21.5.
- FY2024 - 7 brokers - mean of $12.22 and low/high of $11.91 - $12.47. Using the mean, the forward adjusted diluted PE is ~20.
SYK's valuation based on guidance is becoming increasingly attractive.
I anticipate further revisions to broker guidance over the coming days given that SYK just recently released results.
Final Thoughts
Despite COVID headwinds, the underlying demand for SYK's products remains strong. Coupled with a robust order book for its capital products, management remains confident SYK will be able to drive market-leading growth when the impacts of the pandemic subside.
It is difficult to know how long the COVID headwinds will persist. SYK will be challenged to achieve FY2022 guidance the longer these headwinds persist.
I am going to gradually acquire additional shares on weakness rather than through one significant additional purchase.
In my November 22 post, I conclude that I am patiently waiting for SYK's FY2021 forward-adjusted diluted PE to retrace to a level below 27. Based on management's guidance at the time of that post, SYK's share price would have had to retrace below $246. The current valuation is more favourable than at the time of my November review so I have acquired additional shares in an account for which I do not disclose details. Despite this additional purchase, SYK still does not fall within my top 30 holdings.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long SYK.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.
