Is This Medical Device Maker Poised for Higher Growth?

Medical device maker Stryker recently reported strong third-quarter revenue growth, offset by a big dip in earnings, caused by several high-profile recalls. Despite this uneven growth, the company -- which recently expanded into China and acquired surgical robot maker MAKO Surgical -- has been a strong performer over the past 12 months, climbing nearly 40%, and outperforming the market by a wide margin.

SYK Chart

Source: YCharts.

Is Stryker well positioned to continue climbing, or does the stock need to cool down while the company rectifies the problems weighing on its bottom line?

A lopsided third quarter
Stryker's third-quarter earnings fell 70.4% year over year to $0.27 per share. That big dip was caused by ongoing costs from two recalls and acquisition-related charges. Excluding those one-time charges, Stryker's earnings climbed 1% to $0.98 per share.

Revenue rose 4.8% to $2.2 billion. By comparison, Stryker's closest competitor, Zimmer Holdings , reported 4% revenue growth last quarter. Zimmer is scheduled to report its third-quarter earnings on Thursday.

Stryker's sales growth also compares favorably to Johnson & Johnson , which reported a 2% sales decline in its medical devices & diagnostics business during the third quarter. J&J acquired Synthes, one of Stryker's main competitors, last June for $19.7 billion to grow its orthopedic device business.

Stryker's business is split into three main segments -- reconstructive (orthopedic implants), medsurg (surgical equipment, imaging systems), and neurotechnology and spine (spinal implants). Sales at all three segments rose from the previous year.


Third-Quarter Revenue

Growth (YOY)

Percentage of Total Revenue


$949 million




$792 million



Neurotechnology & Spine

$410 million



Source: Stryker Q3 earnings report.

Stryker's reconstructive segment's growth was fueled by strong sales of hip implants, which rose by 9.3%, along with trauma and extremities products, which climbed 22.7%.

The medsurg segment was supported by a 10.5% increase in endoscopy products, which was offset by the aforementioned recalls and an unfavorable comparison to the prior year quarter, when it reported strong sales for its System 7 surgical power tools. The neurotechnology and spine segment's top line was mainly fueled by 14% sales growth in neurotechnology products.

Opportunities for growth abroad
67% and 33% of Stryker's sales are generated by its U.S. and international markets, respectively. During its conference call, the company noted that it registered positive year-over-year growth in Europe and experienced strong double-digit sales growth in China, Brazil, and India.

That robust growth should continue with its $746 million purchase of Chinese orthopedic implant maker Trauson Holdings in March. Stryker is aiming Trauson at lower-income areas and its namesake brand at higher-income ones, which could boost its market share considerably in China and other emerging markets.

Three possible weaknesses
However, Stryker has three exploitable weaknesses that investors should watch out for.

First and foremost, Stryker's acquisition of MAKO Surgical for $1.65 billion gives it an impressive edge over Zimmer Holdings and Johnson & Johnson by expanding into robotic surgery, but it is also a very risky move.

Stryker paid a whopping 87.5% premium for MAKO, an unprofitable company that generated only $102.7 million in revenue in 2012. In addition, the problems that are plaguing robotic surgery market leader Intuitive Surgical -- safety concerns, an FDA probe, and dozens of patient lawsuits -- do not bode well for the near-term future of robot-assisted surgery. MAKO produces two robotic arms used for minimally invasive, patient-specific orthopedic surgeries.

The second problem for Stryker is quality control. The company recalled its Rejuvenate and ABG II modular-neck hip stems last year, after the implants started corroding and sending metallic shards into the patients' tissues, bones, and bloodstream. It also recalled the Neptune Waste Management System earlier this year, when the system, which passively drains the chest cavity during surgeries, caused two serious injuries and a fatality. These recalls cost Stryker $313 million during the third quarter, and $700 million so far.

Investors and customers have been fairly forgiving, since Zimmer and Johnson & Johnson have experienced similar recalls, but any future recalls will continue weighing down its bottom line.

Last but not least, investors should keep an eye on the earnings impact of the Obamacare medical device tax, which took effect in January. This quarter, the medical device tax reduced Stryker's earnings by $0.03. Wells Fargo analyst Lawrence Biegelsen believes that the medical device tax could eventually reduce Stryker's 2013 earnings by 4.5%.

The Foolish takeaway
Stryker is a company that should grow through its investments in emerging markets and robotic surgery. However, it is also a company that must avoid other costly recalls, and hold off hungry competitors such as Johnson & Johnson and Zimmer Holdings.

In addition, Stryker must deal with the macro problems that are facing all medical device makers -- European austerity measures, decreased budgets for hospitals, fewer elective surgeries, and the U.S. medical device tax.

Therefore, based on its current outlook, there should be more upside than downside for Stryker, although the ride will likely be bumpy.

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Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson and Zimmer Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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