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Stryker Beats Estimates

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Stryker Corporation’s (SYK - Free Report) adjusted earnings of $1.14 a share for the fourth quarter of 2012 beat the Zacks Consensus Estimate by a penny and exceeded the year-ago earnings of $1.02 a share. Adjusted net income increased 11.8% year over year to $436 million.

The adjusted earnings for the quarter exclude charges of $133 million, net of taxes (or 35 cents per share) related to the Rejuvenate and ABG II hip products recall in Jun 2012, charges of $24 million related to the previously communicated headcount reduction and other restructuring moves and $2 million in charges associated with the company’s takeover of Surpass Medical, Orthovita, Memometal Technologies, Concentric Medical and Boston Scientific’s (BSX - Free Report) Neurovascular business.

The Michigan-based orthopedic devices major’s profit (as reported) declined 32.7% to $270 million (or 71 cents a share).    

For the full year, profit (as reported) dropped 3.5% year over year to $1,298 million (or $3.39 a share). However, adjusted earnings per share of $4.07 surpassed the Zacks Consensus Estimate by a penny and exceeded the year-ago earnings of $3.72 a share.

In an effort to expand its foothold in emerging markets, Stryker also announced the acquisition of a leading China-based trauma manufacturing company, Trauson Holdings for $685 million. The deal, expected to close in the second quarter of 2013, will not affect the adjusted earnings guidance for 2013 (excluding acquisition-and integration-related expenses).

Stryker’s fourth-quarter sales grew 5.5% (6.1% in constant currency) year over year to $2,337 billion, marginally beating the Zacks Consensus Estimate of $2,277. The growth was triggered by healthy domestic sales but was partially offset by sluggish international markets, particularly in Europe, and stagnant hospital capital equipment sales.

Volume and mix contributed 7.5% to sales growth, partly neutralized by unfavorable pricing impact and foreign currency exchange translation of 1.4% and 0.6%, respectively. Sales in the U.S. improved 8.7% but international sales remained roughly flat due to the ongoing austerity measures in Europe.  

For the full year, sales increased 4.2% (5.4% in constant currency) to $8,657 million, which exceeded the Zacks Consensus Estimate of $8,598. In 2012, revenue growth, on a constant currency basis, surpassed the company’s guidance of 2.5%–4.0%. U.S. revenues grew 7.4%, while international revenues dipped 1.3% (up 1.9% in constant currency).  

Segments Analysis

Revenues from Stryker’s core Reconstructive unit (offering replacement hip, knees and extremities products) increased 6.7% (or 7.4% in constant currency) to $1,046 million in the fourth quarter. This reflects a marked acceleration from the 1.1% growth achieved in the previous quarter, which implies improving reconstructive market fundamentals.

Domestic hip sales jumped 7.4%, while international revenues edged down 0.4% (up 0.7% in constant currency) in the quarter. The U.S. trauma and extremities business witnessed a 26.4% rise in sales in the reported quarter. However, sales in the international markets dipped 3.3% (down 0.4% in constant currency). Growth in the trauma and extremities franchise in the U.S. was led by robust improvement in Foot and Ankle, market share gain due to product recall by a competitor along with contributions from new offerings and sales force expansion.

Stryker’s knee business has started showing signs of improvement with the U.S. sales growing 9.2% in the quarter. However, international knee sales fell 1.5% (down 0.6% in constant currency). The business is benefiting from the Get Around Knee Direct-to-Consumer campaign.

Revenues from Stryker’s MedSurg segment grew 2.4% (up 2.7% in constant currency) year over year to $877 million, boosted by the Endoscopy and Sustainability Solutions franchises. Volume and mix, and favorable pricing impact contributed 2.2% and 0.5%, respectively, to growth, partly neutralized by an unfavorable foreign currency exchange translation of 0.3%.

Within MedSurg, the 3.5% increase in Instruments sales to $330 million (gains in the Power Tools segment) was partially dampened by the Neptune recall. Endoscopy sales surged 6% to $309 million, driven by the launch of a new camera. However, Medical segment revenues fell 7.4% to $185 million due to soft capital equipment sales and tough year-over-year comparables in the U.S. business. The Neptune recall will continue to adversely affect sales by roughly $17million—$20 million every quarter, until regulatory clearance is obtained, which is unlikely in the first half of 2013.

Stryker’s Neurotechnology and Spine segment continues its solid growth streak with revenues increasing 9.7% (up 10.8% in constant currency) year over year to $414 million. Sales from the Neurotechnology sub-segment climbed 12.7% to $224 million. The company expects favorable traction for its Target Coil and Trevo stent retriever. Quite surprisingly, the spine business too posted sales growth of 6.4% to $190 million, reflecting significant contribution from the Biologics products obtained from the Orthovita acquisition.

Margin Trends

Adjusted gross margin increased by 100 basis points (bps) year over year to 68.3% in the fourth quarter. Growth was driven by favorable mix, currency impact, and cost curtailment efforts by the company’s global quality and operations group. Focused management efforts and controlled operating expenses led to a 120 bps improvement in adjusted operating margin, which came in at 25.3%.

Research, development and engineering expenses, as a percentage of sales, increased to 5.5% from 5.2% a year ago. Selling, general and administrative expenses (as a percentage of sales) rose to 44.2% from 37.7%, primarily due to the aforementioned product recall.

Financial Health

Stryker ended the quarter with cash and cash equivalents and marketable securities of $4,285 million, up roughly 25.4% year over year. Long-term debt remained roughly flat at $1,746 million.

Stryker generated $596 million of cash from operations during the fourth quarter, down 5% year over year. The company did not repurchase any shares in the fourth quarter, thus total repurchases for 2012 remained at 2.1 million (worth $108 million).

2013 Outlook

Stryker has divulged its outlook for 2013. Revenues are expected to grow 3.0%–5.5% in constant currency. The company expects foreign currency (assuming current exchange rates) to unfavorably impact sales by roughly flat to 1% in the first quarter as well as full year 2013.

After accounting for the $100 million pre-tax annualized impact from the Med-Tech excise tax, Stryker expects adjusted earnings in the range of $4.25—$4.40 a share for 2013. The current Zacks Consensus Estimate of $4.32 for 2013 is within the provided guidance.

Further, the company highlighted certain factors, which are expected to affect both top as well as bottom-line growth in 2013. Fewer selling days in the first quarter compared with the year-ago quarter, price reductions in Japan in Apr 2012, the Neptune product recall and the income tax adjustments in 2012 are expected to impact results in 2013. Based on the above mentioned factors, adjusted earnings are expected to grow 23%, 24%, 24% and 29% in each of the four quarters of 2013.

About the Company

Stryker, with a market-cap of $23.46 billion, is one of the world’s largest medical device manufacturers operating in the global orthopedic market. The company’s well-diversified product portfolio, expanding foothold in emerging markets along with acquisitions are expected to drive future growth.

Moreover, the company remains committed to delivering incremental returns to investors, as reflected in the recent 25% hike in dividends and the $1 billion share repurchase program.

However, Stryker faces several challenges, which include continued soft international sales and tough hospital capital budgets. Moreover, despite the recent stability in the domestic market, it remains challenged by the prevailing austerity measures in Europe.

Stryker carries a Zacks Rank #3 (Hold). Medical products companies, such as Edwards Lifesciences Corp. (EW - Free Report) and Hanger Inc. , which carry a Zacks Rank #2 (Buy), are expected to do well. Hanger will be reporting its results on Feb 13.

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