Stryker Corp (SYK) reported disappointing fourth-quarter 2014 financial numbers wherein EPS of $1.44 missed the Zacks Consensus Estimate by a penny and net sales of $2.62 billion lagged the Zacks Consensus Estimate of $2.63 billion.
However, EPS increased 11.6% on a year-over-year basis driven by 6.1% growth in net sales and 80 basis points (bps) operating margin expansion. At constant currency (cc), net sales improved 8.6% from the year-ago quarter.
Organic growth was 5.5% in the fourth quarter, driven by improving volume and product mix, partially offset by pricing headwinds. Acquisitions added 3.1% while a strong U.S. dollar negatively impacted overall sales by 2.6% in the quarter.
The year-over-year growth in net sales was primarily led by robust performance from the MedSurg segment. Operating margin expansion resulted from a 130 bps improvement in selling, general & administrative expenses (SG&A) as percentage of revenues.
The lower SG&A expenses fully offset a 20 bps decline in gross margin and 20 bps increase in research, development & engineering (R&D) expenses. Pricing headwinds, negative product mix and a strong U.S. dollar continued to negatively impact gross margin growth.
Segment Details
U.S. sales were up 11.1% year over year to $1.82 billion driven by higher demand for orthopedic products (up 7.3% from the year-ago quarter), strong MedSurg growth and double-digit growth in Neurotechnology. International sales declined 3.8% year over year (up 3.8% at cc) to $800 million, primarily due to challenges in Japan.
Orthopedic sales increased 1.7% (4.5% at cc) to $1.11 billion riding on 9.1% growth in Trauma & Extremities sales and 12.5% jump in other sales. This fully offset a 2.9% and 2.2% decline in Hips and Knees sales, respectively.
Trauma & Extremities sales in the U.S. surged 18.7%. The segment reported mid-single digit growth in the International market. Hips delivered strong performance in the U.S., with sales growth of 4.5% in the quarter.
However, International sales in both the segments dropped due to pricing headwinds and operational problems in Japan.
In the fourth quarter, MAKO procedure volume increased double-digit on a year-over-year basis. Notably, Stryker sold 20 robots in the quarter. In late 2014, the company filed a 510-K application with FDA for MAKO total Knee. The company expects to gain FDA approval in 2015 and meaningful sales contribution in 2016.
MedSurg sales surged 12.1% year over year to $1.05 billion (14.1% at cc) driven by robust performance across the group. Organic was particularly strong at 9.4%. The company’s Neptune product (re-launched in the first quarter of 2014) helped it gain market share in the Instruments business. Sales were up 12.3% on a year-over-year basis in the reported quarter.
Endoscopy, Medical and Sustainability sales grew 10.8%, 16% and 6%, respectively. The year-over-year growth in Endoscopy benefited from the recent acquisitions. An uptick in the hospital capital spending environment positively impacted Medical sales figure.
Finally, the Neurotechnology and Spine segment grew almost 3.9% (7% at cc) to $262 million, primarily owing to 9.2% growth in Neurotechnology sales. Spine sales declined 2.5% on a year-over-year basis in the said quarter.
Liquidity
Stryker ended 2014 with cash & cash equivalents (including marketable securities) of $5 billion. Long-term debt was $3.2 billion, while the company generated $1.78 billion in cash flow from operations in 2014. At the end of 2014, Stryker had $500 million available under its ongoing share repurchase program.
Outlook
Stryker believes that the new European regional headquarters (in Amsterdam) and the recently launched operating model (transfer of intellectual property from other countries in Europe to the Netherlands, repatriation of $2 billion from Europe to the U.S.) will improve its position in the Western European market.
Stryker also remains bullish on the growth prospects in China and India. However, volatile foreign exchange is expected to negatively impact 2015 EPS by 30 cents. A strong dollar against other foreign currencies is expected to negatively impact full-year sales by 3% to 4%. Pricing is also expected to remain a major concern in 2015.
For 2015, Stryker forecasts organic sales growth in the range of 4.5% to 6%, while earnings are expected in the range of $4.90 to $5.10 (up 4% to 8%). At cc, sales growth is projected in the range of 5.5% to 7.0%, while EPS growth rate guidance is in the 10% to 14% range for the fiscal year. For 2015, capital expenditures are forecasted to be more than $300 million.
For the first quarter of 2015, Stryker expects EPS in the range of $1.05 to $1.10. The company expects strong dollar to negatively impact sales by approximately 3% to 4% and EPS by approximately 8 cents.
In the second quarter of 2015, Stryker expects to launch a new knee product on the MAKO robot. The company also expects to launch hip power brands (including accolade hip) on the robot as well as X3 poly bearings in 2015.
Our Take
Stryker’s fourth-quarter results failed to impress us. The company did not buy back any shares in the quarter as it plans to pursue acquisitions in the near term. We remain skeptical about this strategy, primarily due to a debt-laden balance sheet, which is a result of frequent acquisitions.
Reportedly, the company is gearing up to bid for London-based Smith & Nephew (SNN). Per Bloomberg, the deal will be structured as tax-inversion, which will enable Stryker to change its legal address to the lower-taxed U.K.
Apart from the tax-advantage, a possible Smith & Nephew deal also presents significant top- and bottom-line synergies for Stryker in the near term. We believe that a possible deal will further expand Stryker’s product pipeline.
However, the U.S. government’s recent stance regarding tax-inversion has made these kinds of deals tough to pass. Moreover, the deal is expected to face significant antitrust regulation in both the U.S. and Europe.
Moreover, the declining Hips and Knee sales in the U.S. remains a concern. On the International front, market share loss in Japan – which is Stryker’s largest market internationally – will continue to hurt top-line growth. However, a better-than-expected performance from Europe is expected to somewhat offset this Japanese concern in 2015.
We believe that Stryker’s innovative product pipeline will be a key growth catalyst in 2015. Also, the growing adoption of MAKO will drive sales in the orthopedic and reconstructive surgery market. Additionally, contract wins from large hospitals in the foot and ankle business also presents significant growth opportunities.
Zacks Rank
Currently, Stryker has a Zacks Rank #3 (Hold).
Other better-ranked stocks are ICU Medical (ICUI) and Nxstage Medical (NXTM). Both companies sport a Zacks Rank #1 (Strong Buy).
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