2023-04-27 16:45:56 ET
Summary
- SYK’s recent track record during earnings season is quite mixed.
- A recovery in procedural volumes, reduced staffing pressure, and the easing of COVID restrictions in Asia Pac should help.
- SYK needs to start performing on the FCF front to justify its premium valuation.
- The stock looks overextended and could do with a pullback.
Company Snapshot
Stryker Corporation (SYK) is a medical technology firm whose products are marketed and distributed to various doctors, hospitals, and healthcare facilities in over 75 countries across the globe. The product expertise of Stryker lies in terrains such as medical surgery, neurotechnology, spinal, and orthopedics.
A Few Earnings-Related Considerations
SYK will report its Q1 results on May 1, post-market hours. Given its patchy record during earnings season, there will understandably be some nerves amongst stakeholders of SKY. As you can see from the image below, over the last eight quarters, the company has failed to meet EPS estimates 50% of the time, whilst just about meeting street estimates once.
Even though SYK will benefit from one additional working day in Q1-23, YoY EPS dynamics could remain subdued on account of lingering inflation dynamics, something that wasn't present a year ago. For context, the sell-side club is currently expecting a Q1 EPS figure of $2.00 , which would represent earnings growth of 2% YoY.
On the revenue front, it's worth recollecting that the company closed last year on a very strong footing, delivering record net sales growth of 11% , buoyed by organic growth of 13% YoY. For FY22 as well, organic growth was quite solid at 10%. Given the strong base effect, it's reasonable to expect some slowdown in the current fiscal year. In fact management suggested they would likely only deliver organic growth of 7-8.5% for the current year. In Q1 alone, consensus is currently budgeting for a sales figure of $4.56bn, which would represent reported growth of 6.6% (As 26% of group sales comes from abroad, FX is likely to serve as a headwind in Q1).
In Q1, SYK is likely to benefit from an ongoing recovery in procedural volume in areas such as hip, spine and knee surgery. A recent survey conducted by Guidehouse showed that a healthy chunk of c-suite hospital executives expects a 10% increase in elected procedures this year. Procedural volumes would likely have gotten a fillip from improving labor force conditions in the healthcare space. A recent study by Altarum highlighted how hospital employment levels had now crossed pre-pandemic levels.
Asia-Pac procedural volumes were previously flagged as sub-optimal by SYK management, but given the dissipating impact of COVID-related restrictions there, you would think this terrain would give a bump in Q1. If Asia-Pac can bounce back in Q1, one would expect the outperformance of the international segment over US growth to continue once again.
If SYK is to justify its premium valuation (more on the valuation in the next section), investors will want to see an improvement in the FCF dynamics which have slumped from the $3bn TTM (trailing twelve months) run rate seen around 18 months ago to around $2bn or so. Meanwhile also consider that the stock's current FCF yield (1.78%) is a good 50bps below what you normally get
In recent periods, a lot of the FCF pressure has come from inventory builds and a spike in accounts receivables. SYK management had previously resorted to pre-buying and building heavy inventory buffers to negate some of the supply chain risks. You would hope that with an improving supply position for electronic components and steel in Q1, these heightened inventory levels would be drawn down. On the accounts receivable front, there typically tends to be a spike towards the end of the year, and SYK would likely have benefitted from better collections in Q1 which should abet the operating cash flow even further.
We'd also be curious to see if SYK has been able to ameliorate some of the margin-related pressures through better pricing initiatives and restructuring actions in Q1. For context, in Q4, adjusted operating margins were down by 70bps!
Valuations
Stryker's earnings growth prospects over the next two years look good enough; as per sell-side estimates , the company could generate 7% earnings growth this year, and deliver even better figures of 11% earnings growth in FY24. However, despite the solid enough earnings growth runway, we would be hesitant to pay a forward P/E (based on the FY24EPS) multiple of 27x, particularly as it represents a 15% premium over the stock's long-term average multiple. Also note that since January 2022, whenever the stock gets close to 27x P/E, we never saw further P/E expansion.
Closing Thoughts - No Incentive To Go Long
At the start of H1-22, one could have made the case for Stryker as an interesting rotational play within the medical devices sector, but at this juncture, that thesis has gone out the window. The relative strength ratio of SYK and the iShares US Medical Devices ETF ( IHI ) has already mean-reverted to the mid-point of its long-term range, offering limited incentive for rotation.
If we switch over to SYK's standalone long-term chart, note that the stock has been trending up in the shape of an ascending broadening wedge pattern over time.
If one were to contemplate a long position at this juncture, it's pretty clear that the risk-reward looks unfavorable, with the stock inches away from the upper boundary of the wedge. Crucially also note the presence of the upper wick in April's candle, which has convened in tandem with the price action trading just above two standard deviations from the 20-day moving average. This suggests that the price action looks overextended with some additional supply of the stock coming into the market when it crosses the psychological level of $300.
Interestingly enough, also note that the influential institutional segment of investors has also been relentlessly trimming their positions in SYK. Since December 31, 2022, the net shares owned by this cohort have declined in every successive month through the end of March.
All things considered, it's clearly not the best time to start a long position in the stock. SYK is a HOLD.
For further details see:
Stryker: Q1 May Be Fine, But The Prospect Of Outsized Gains Looks Unlikely