Barron's; Stryker Stock Can Stay Hot, Helped By M&A

Stryker Stock Can Stay Hot, Helped By M&A
Despite a big run this year, shares of the medical device maker look cheap. Also, why Goldman Sachs put Stryker on its “Conviction Buy” list.

Advancing age, obesity and injuries can wear on hips and knees, which is bad news for Baby Boomers, but good news for Stryker.

As one of the biggest makers of implants used to replace and repair damaged hips, knees and other joints, Kalamazoo, MI-based Stryker should strongly benefit from a coming wave of surgeries in the U.S. and elsewhere.

Stryker (ticker: SYK ) has spent billions on acquisitions in the past five years and now generates most of its revenue from products that have nothing to do with hips or knees.

This strategy has paid off. The stock has returned more than 30% in the past 12 months, closing Thursday at $95.83, compared to the 13% gain by the S&P 500.

Though Stryker stock reached an all-time high today, we don’t think investors fully appreciate the underlying value and see ample upside.

Stryker already boasts industry-leading organic sales, which exclude acquisitions, growth. It also has one of the strongest balance sheets in the industry and should continue to capitalize on accretive deal making that drives sales in fast-growing markets and expands its reach outside the U.S.

At 18.4 times 2015 estimated earnings, Stryker trades at a slight discount to the broader medical device industry, having historically averaged a 10% premium. Return it to that premium, and the shares, which yield 1.5%, could climb to $108.

“The stock has performed well year to date, but in my opinion, it has not been given the level of credit given to cash-deploying, shareholder value-creating, acquiring companies in their multiples,” says Leerink Swann analyst Richard Newitter. “Stryker has room to play catch-up.”

Others agree. Earlier this month, Goldman Sachs added Stryker to its “Conviction Buy” list, citing, among other tailwinds, a strong balance sheet and what analyst David Roman calls “a demonstrated ability to do deals.”

Founded in 1941, Stryker is the fifth-largest medical device company in the S&P 500 based on 2013 revenue of $9 billion, and a prominent player in the $38 billion orthopedic-implant market, where it competes with Johnson & Johnson ( JNJ ), Zimmer Holdings ( ZMH ), Medtronic ( MDT ) and others.

Last year, Stryker derived 44% of revenue from reconstructive products, with sales of hip and knee implants alone exceeding $2.5 billion. The medical-surgical products business chipped in $3.3 billion, or 37% of company-wide revenue, while the other 19% came from spinal implants and neuro-technology products.

That’s quite a change from 2009, when orthopedic devices generated almost 60% of Stryker’s business.

But a lot has changed since then.

The financial crisis and the resulting recessions hit device makers hard both here and in Europe. The industry, however, bounced back quickly, helped by the extension of health benefits to millions of Americans via the Affordable Care Act and an improving economy in the U.S., where unemployment is falling and hospital admissions are rising.

Stryker has also broadened its international footprint in recent years by snapping up companies with new technologies and entering fast-growing markets.

In 2010, Stryker paid $1.5 billion for Boston Scientific’s ( BSX ) neurovascular business. From 2011 to 2013, it spent $4.5 billion on acquisitions, including the $1.6 billion purchase of Mako Surgical and $765 million acquisition of Trauson Holdings that expanded Stryker’s presence in China.

Organic sales growth exceeded 5% in 2013. Goldman Sachs’ Roman sees that reaching 6% to 7% as the macroeconomic environment continues to improve for device makers.

In 2015, Roman expects revenue to exceed $10 billion, yielding $5.24 a share in earnings. Analysts surveyed by Thomson Reuters expect earnings of $5.20 a share.

Stryker still has plenty of dry powder for deals with $4.7 billion in cash on its balance sheet, compared to $3.9 billion in debt. Stryker also plans to repatriate $2 billion in overseas cash by June.

In May, reports surfaced that Stryker was considering a bid for its European rival Smith & Nephew ( SNN ), a deal that would strengthen its presence outside the U.S. and propel the company ahead in the markets for sports medicine and products used to treat trauma. It would also add scale to its U.S. hip and knee business.

Rival Zimmer leapfrogged Stryker earlier this year with its $13.4 billion acquisition of rival Biomet (see Barron’s Take, “Zimmer Attractive After $13.4 billion Biomet Purchase,” April 24).

Questions remain as to whether Smith & Nephew is a willing seller or whether U.S. antitrust regulators would approve a deal. Yet Smith & Nephew isn’t the only way that Stryker can create more value. “Should the deal not happen, we still expect Stryker to be an active acquire,” notes Leerink’s Newitter.

And we still expect Stryker’s stock to keep rising, whether Smith & Nephew becomes part of the company or not.

>>> Portugal Telecom: Isabel dos Santos mulls final decision on EUR 1.21bn bid -

Portugal Telecom: Isabel dos Santos mulls final decision on EUR 1.21bn bid

Isabel dos Santos, the Angolan entrepreneur, has still not decided whether to withdraw her EUR 1.21bn bid for Portugal Telecom (PT), reported Jornal de Negocios. The online version of the Lusophone business paper quoted a source in Terra Peregrin, the vehicle that made a EUR 1.35 per share bid on PT, as saying dos Santos is still studying various options over PT and has not pulled out of the process.

A Lisbon business paper reported Thursday that dos Santos would withdraw her PT bid, but still remain focussed on potential opportunities arising from consolidation of telco markets in Portugal and Brazil.

Portugal's CMVM stock market regulator said earlier this week the dos Santos bid on PT would have to be raised in value and also declined to grant the request for a mandatory offer waiver made by the Angolan investor, daughter of longtime Angolan leader Jose Eduardo dos Santos.


Jornal de Negocios

>>> US Gapping down

In reaction to disappointing earnings/guidance: FINL -9.7% (light volume), BBRY -5.3%, BGCP -2.7%, NKE -2.6%, NQ -2.6% (also announces proposal to sell FL Mobile to Tack Fiori International Group Limited and become controlling shareholder).

Select pharma stocks trading lower: RHHBY -6% (Immunogen reported that Roche has announced top-line results of its Phase III Marianne study; Roche has reported the Marianne study showed the three regimens helped people live without their disease worsening ), SHPG -1.8%, AZN -1.8%, SNY -1.7%.

Select Euro financial related names showing weakness: BBVA -3.1%, SAN -2.9%, ING -2.6%, DB -1.9%...oil/gas related names: STO -2.3%, TOT -1.7%... telecom names are lower: PT -7% CHA -6.1% (ticking lower), TI -2.2%

Other news: IMGN -39.2% (Immunogen reported that Roche has announced top-line results of its Phase III Marianne study; Roche has reported the Marianne study showed the three regimens helped people live without their disease worsening ), RXII -11.9% (entered into an assignment and exclusive global license agreement with Hapten Pharmaceuticals for the therapeutic use of Samcyprone), NVGN -8.4% (entered private placement), GFI -3.6% (still checking), YNDX -2.7% (ongoing Russia related volatility), CRH -2.4% (still checking), NOK -2% (following BBRY results), TNK -1.9% (plans to offer 20,000,000 shares of Class A common stock; downgraded to Neutral from Buy at UBS, tgt raised to $6 from $5.50), BUD -1.9% (still checking), DEO -0.8% (still checking), MET -0.6% (has been designated as systemically importan by regulatorst, as expected), UA -0.5% (following NKE results), .

Analyst comments: SDRL -6.1% (downgraded at Goldman), EVC -1.4% ( downgraded to Neutral from Outperform at Wedbush ), MXIM -0.4% (downgraded to Neutral from Buy at Goldman), WAG -0.2% (downgraded to Neutral from Buy at SunTrust)
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>>> US Gapping Up

In reaction to strong earnings/guidance: RHT +10.6%, PIR +7.9%, CTAS +7.3%.

M&A related: APP +4% (following late spike higher following NYPost report of takeover offer valuing company at $1.30-1.40/share), XRX +3.7% (Atos to acquire Xerox's information technology outsourcing business for $1.05 bln; does not anticipate earnings per share dilution beyond 2015; updates Q4 and FY15 guidance to reflect acquisition), CBST +1.3% (Merck (MRK) begins tender offer to acquire Cubist for $102.00 per share in cash), UTIW +0.8% (responds to Bloomberg report that UTIW is in 'advanced talks' to sell itself to DSV; UTIW states that those discussions never progress beyond a preliminary stage) .

A few Brazil names are trading higher: BRFS +3.9%, PBR +2.2% EBR +2.5%, CBD +1.5%

Other news: PETX +26.2% (announced positive top-line results from AT-001 pivotal field study in client-owned dogs with osteoarthritis), MOLG +13.7% (announces commencement of share repurchase program), CERS +13.6% (FDA approves intercept blood system for platelets), ISIS +7.1% (among stocks with favorable commentary on Thursday's Mad Money), MSG +4.6% (authorized and directed mgmt also to consider other spin-off structures including separation of the media business from its sports and entertainment businesses), KEG +3.7% (after 35% move higher yesterday), ALLY +3.3% (files for offering of common stock, size not disclosed; U.S. Department of Treasury launched offering to sell its remaining ~54.9 mln shares of Ally common stock), OREX+3.3% (confirms that the Committee for Medicinal Products For Human Use of the European Medicines Agency has adopted a positive opinion recommending the granting of a centralized marketing authorization for Mysimba), OGXI +3.1% (nnounced results from the randomized, controlled Phase 2 Borealis-1 trial evaluating low and high dose apatorsen in combination with gemcitabine/cisplatin chemotherapy compared to chemotherapy alone in the treatment of metastatic bladder cancer), RCAP +2.5% (following yesterday's 15%+ move lower following ARCP news; issues statement regarding recent market developments; says 'here have been no reported accounting irregularities at RCS Capital'), MBT +2.5%/ VIP +1% (Mobile TeleSystems partnered with VimpelCom to jointly roll-out and utilize LTE networks in 36 Russian regions), SIMG +2.4% (after 30% move lower yesterday), FRO +2.3% (cont strength), Q +1.9% (among stocks with favorable commentary on Thursday's Mad Money), TICC +1.3% (adopts stock repurchase program of up to $50 mln worth of common shares), PTCT +1.1% (Translarna Granted Orphan Drug Designation in the U.S. and Europe for the Treatment of Mucopolysaccharidosis), CQP +0.7% (Cheniere and GE Sign $1B Service Agreement for Sabine Pass LNG Export Terminal), NRZ +0.7% (increases quarterly dividend), GILD +0.4% (Gilead Sciences and Ono Pharma (OPHLY) announced that the companies have entered into an exclusive license agreement for the development and commercialization of ONO-4059), KO +0.3% (Coca-Cola Bottling Co. announces agreement with Coca-Cola to expand franchise territory).

Analyst comments: POT +1.8% (upgraded to Buy from Neutral at UBS; tgt raised to $40 from $38), ORAN +1.1% (upgraded to Buy from Hold at Deutsche Bank), RYAAY +1% (upgraded to Outperform from In-line at Imperial Capital; tgt raised to $85 from $60), IRBT +0.7% (initiated with Overweight and $42 target at Piper Jaffray),-hammer and fly after TWTR +0.7% (initiated with Perform at Opco; tgt $36), MPW +0.6% (upgraded to Hold from Underweight at KeyBanc Capital Mkts), AAPL +0.3% (positive Morgan Stanley comments related to iPhone demand
)

FT LEX : You can’t kill the S&P, can you? USA! USA! Or maybe not.


• What could possibly reverse US stocks? Lex thinks that the US has become a safety trade — as can be seen in the leadership of big-cap stocks and defensive sectors. So if the rest of the world starts to look a bit better (hard to imagine at the moment, of course, but that is exactly the point) the trade could unwind badly. Alternatively, if US companies could stop buying vast piles of their own shares, the treads will come right off the tank. Why this would happen Lex doesn’t know, but we’re thinking about it.
• What is the way to play emerging markets next year, given their sensitivity to all the factors that US shares ignore? Well, one can look to companies that sell to the US, such as manufacturers in Taiwan and Korea. Or one could hope for further political alpha in India.
• Thailand is an emerging market that has done well recently, particularly since the military coup in May. A tremor in SET index this week might just have been business as usual for an illiquid emerging market index. But the Thai economy is not strong. Political stability may not last for ever. Lex Advanced Long/Short Advisors is short the SET (note: LALA does not exist, and wouldn’t give investing advice if it did).
• What is a company to do if it is not lucky enough to be in the US? It is to merge. BT plans to buy EE, giving the full wireless/landline data package. It’s a sensible, if not wonderfully cheap, deal. It is worth saying, though, that it has nothing to do with growth. It’s about establishing a stable customer base and cutting costs.
• BP is about as far from the safety of the US as it is possible to be. It is up to its chest in Russia. It owns a fifth of Rosneft. Its dividend from Rosneft comes in roubles. And Rosneft contributes most of its forecast production growth. A further oil price decline will put the Russian company’s production targets in danger.
• Is 2015 the year when a cyber attack does permanent damage to a major corporation? Sony’s troubles with The Interview this week give a small taste of how an anonymous (not to say Anonymous) cyber thug can have a business impact. Lex hopes that the hoodlums behind the attack are forced to watch as Sony makes The Interview, despite the lack of a theatrical release, into an economic or public relations success.
To close on a seasonal note: Lex does not wish a Merry Christmas to executives who get paid based on the basis of total shareholder returns during their time in charge, whether with options or otherwise. We join an increasing number of pundits in pointing out that this doesn’t seem to be working out well for companies or shareholders. Bah humbug! Normal old salaries next year!
Season’s greetings to everyone else, and our thanks for reading the column this year.
All best
Robert Armstrong
Head of Lex

>>> US Early premarket gappers

Early premarket gappers

Gapping up: PETX +26.2%, CERS +13.6%, RHT +11.1%, PIR +7.9%, CTAS +7.3%, ISIS +7.1%, KEG +3.7%, XRX +3%, SIMG +2.4%, FRO +2.3%, COOL +2.2%, MSG +1.9%, POT +1.8%, CQP +1.6%, ALLY +1.5%, TICC +1.3%, ORAN +1.1%, COKE +0.9%, GILD +0.4%, RCAP +0.3%

Gapping down: SDRL -7%, PT -7%, BBRY -4.7%, YNDX -2.7%, BGCP -2.7%, CRH -2.4%, STO -2.3%, NKE -2.1%, TNK -1.9%, BUD -1.9%, DB -1.9%, SHPG -1.8%, TOT -1.7%, DEO -0.8%, MET -0.6%, UA -0.5%, NQ -0.4%