Streetwise for Sunday, August 5, 2018

As an owner and lover of horses, I continue to be amazed by what Peter Lynch wrote in his 1989 best seller, “One Up on Wall Street.” According to Lynch, the Greeks used to sit around and debate the number of teeth a horse has. Somehow, they thought that was a better method than counting the teeth in a sampling of horses.

In a like manner, many investors sit around and debate whether the markets are going higher or lower, as opposed to “counting the teeth” of potential investments.

Lynch made another observation. He pointed out that investment opportunities are often derived from your own experiences. To that end, I want to revisit Stryker Corporation (SYK), a company I can relate to because they produce implants for knee replacements, among other products, of which I have two.

When I wrote about the company a year ago, my earnings estimate for the 2017 fiscal year was $6.45 per share with a 12-month projected share price of $161, yielding a 10 percent capital gain. There was also at that time an indicated dividend of 1.15 percent.

So how did the company do? Earnings for the year came in at $6.49 and the shares recently closed at $165.21. Put another way, in a year’s time Stryker’s shares have rallied 18.6 percent compared with the industry’s rise of 13.1 percent. That is fine of course, however the key question, as always, is what Stryker will do going forward.

Stryker released its second-quarter results on July 24. Net sales increased 10.3 percent over the same period a year ago, coming in at $3.3 billion. Stryker’s Neurotechnology and Spine segment, which grew by 19.4 percent, was the greatest contributor to the company’s revenue growth.

Sales from its other two segments, Orthopaedics and MedSurg, grew by 7.6 percent and 8.9 percent, respectively. The increase in the company’s revenues came from higher unit volumes and was partially offset by lower prices.

The company reported second quarter net income of $452 million, an increase of 15.6 percent over the $391 million of a year ago, resulting in earnings per share of $1.19 as compared to $1.03 in the same period a year ago.

Stryker’s gross profit increased from $1.99 billion in second quarter of 2017, to $2.19 billion in the second quarter of 2018. However, gross margin fell by 20 basis points or 0.20 percent to 65.9 percent.

Meanwhile, total operating expenses increased by 1.9 percent year over year, from $1.49 billion to $1.52 billion, although operating margins did expand from 16.7 percent in 2017 to 20.2 percent in 2018, an increase of 3.5 percent. Operating income totaled $672 million, an increase of 33.9 percent from the prior-year quarter.

Stryker exited the second quarter with $1.9 billion of cash and marketable securities. However, total debt remained unchanged at $7.2 billion. Cash flow from operations was $946 million.

For the upcoming third quarter adjusted net earnings per share are projected at $1.65 to $1.70. If foreign currency exchange rates remain at current levels, look for net sales in the third quarter to be negatively impacted by approximately 0.9 percent.

For the year, net sales will be positively impacted by approximately 0.5 percent and net earnings per share will be currency neutral in the third quarter and positively impacted by $0.05 per share for the full year.

For fiscal 2018, Stryker expects organic sales growth of between 7 and 7.5 percent and earnings per share of $7.22 to $7.27. For third quarter, Stryker expects net earnings per share of $1.65 to $1.70.

Expansion of the company’s operating margin bodes well. Continued focus on research and development show increasing emphasis on innovation. However, the decline in gross margin is of concern and debt levels remain unchanged.

The intrinsic value of the shares using a conservative free cash flow to the firm model produces an intrinsic value of $184.18 per share. My earnings estimate for this fiscal year is $7.25 per share with a 12-month projected share price of $182, yielding a 10 percent capital gain. There is also an indicated dividend of 1.08 percent.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.