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Stryker Stays Neutral

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We are maintaining our Neutral recommendation on Stryker Corp. (SYK - Free Report) with a target price of $55.

Stryker reported third quarter 2012 adjusted earnings of 97 cents per share, which missed the Zacks Consensus Estimate by a penny but surpassed the year-ago earnings of 91 cents per share (up 6.6%). However, profits increased 8% year over year to $353 million (or 92 cents a share), primarily led by higher domestic sales and cost containment measures.

Revenues inched up 1% (up 2.9% in terms of constant currency) year over year to $2,052 million, but fell short of the Zacks Consensus Estimate of $2,070 million. Revenues increased on the back of healthy sales across all U.S. franchises (except Medical) but were largely offset by weak international and capital equipment sales.

Stryker is one of the world’s largest medical devices companies and we feel that it should benefit from new product launches, strategic acquisitions, cost control measures and increasing operating efficiency. Moreover, new management’s long-term growth strategy represents a potential upside.

Stryker continues to expand its product portfolio by acquiring complementary businesses leveraging a solid balance sheet. Recently in November 2012, the company’s neurovascular division acquired Surpass Medical to expand its Complete Stroke Care portfolio. Surpass’ mainstay, the CE-Marked NeuroEndoGraft family of flow diverters is an attractive addition to the company’s product line.

Further, the company is regularly introducing new products to expand its business. The recently introduced small Target nano Detachable Coil and the Trevo stent retriever are considered to be the latest growth drivers for the Neurovascular segment. The Trevo stent retriever won the 510(k) approval in the month of August 2012. Moreover, the Instrument business is benefiting from solid sales of the System 7 Power Tool that the company launched in late 2011.

Barring the Medical business, Stryker’s domestic business is growing at a healthy pace, recording a 4.7% growth in the quarter under review. Domestic Knees and Trauma and Extremities sales within the Reconstructive division have started showing signs of improvement with Trauma gaining significant grounds, led by acquisitions.

Moreover, the MedSurg division continues its healthy growth momentum, triggered by the Instruments and Sustainability Solutions businesses. The Neurotech franchise is posting strong results on the back of new products as well as acquisitions.

However, revenues were negatively impacted by weak international sales and stringent global capital spending environment, which is mostly affecting the company’s Reconstructive and MedSurg businesses. As a result, Stryker lowered its guidance for 2012 as well as 2013 in its third quarter results.

Stryker expects adjusted earnings for 2012 to be in the range of $4.04—$4.07 (up 9%). Earlier, the company had expected adjusted earnings to grow at double-digit levels for 2012. For 2013, Stryker expects adjusted earnings to be in the band of $4.25 and $4.40.

In terms of constant currency, the company narrowed its revenue forecast, and expects revenues to increase in the range of 4% to 5.5% (earlier 3.5% to 6.5%) for 2012. Excluding the impact of acquisitions, the company expects revenue to increase in a band of 2.5% and 4% (earlier 2% to 5%).

The company’s mainstay, the orthopedic Reconstructive business is facing tough challenges and losing market share due to uncertainties prevailing in Europe. Apart from macroeconomic headwinds, internal shortcomings are hampering sales as well. Despite the U.S. franchises showing signs of stability, Stryker needs to focus and execute before a combination of both external and internal issues start affecting the business adversely.

The orthopedic industry is highly competitive and Stryker faces strong competition from players like Zimmer Holdings, Inc. . The company remains challenged by the upcoming MedTech device tax along with pricing pressure and currency fluctuation. Furthermore, Stryker witnessed a few product recalls recently, which is offsetting revenue growth.

We currently have a long-term ‘Neutral’ recommendation on Stryker. The stock carries a short-term Zacks #4 Rank (Sell).

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