Strike While The Iron Is Hot: Stryker (SYK)

Stryker (SYK) is a rarity in the current market: a strong business with a stock that is still attractively valued. A leading supplier of medical implants, surgical tools, and neurosurgical equipment in 100 countries, Stryker has grown revenue and profits every single year since 2000 and earns a top-quintile return on invested capital (ROIC). Based on Stryker’s long history of strong profit growth and key tailwinds in the medical device industry, I think the stock is undervalued at ~$84/share.

Profits Are Better Than You Think

Figure 1 shows that Stryker’s operating profit (NOPAT) rose while GAAP net income declined in 2012 and 2013. In 2013, Stryker’s NOPAT exceeded its GAAP net income by over $1 billion.

Investors should focus on NOPAT rather than net income. Last year, Stryker incurred over $1 billion in non-recurring charges related to increased liability reserves and voluntary recall costs for the company’s Rejuvenate hip replacements and Neptune waste management systems. NOPAT excludes these unusual costs.

We expect these charges to be much lower in the future as the company has already taken large reserves for the hip replacement recall and has resolved the issues with its Neptune systems. As a result, Stryker’s rising NOPAT provides a more accurate picture of the cash flows investors can expect from the company going forward.

Figure 1: Focus On NOPAT, Not Net Income

Stryker_NOPAT

Sources:   New Constructs, LLC and company filings.

Stryker increased its return on invested capital (ROIC) from 5% in 1999 to a top-quintile 30% in 2013. Even more impressively, the company has grown NOPAT every single year since 2000 at a rate of 18% compounded annually. Stryker has shown the ability to grow profits and sales in any economic climate.

Consistent cash flow growth has kept Stryker’s balance sheet in good shape. Stryker has $3.8 billion in excess cash, more than enough to cover the company’s $3 billion in total debt.

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Disclosure: NewConsructs staff receive no compensation to write about any specific stock, sector, or theme.

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