Stryker Stock Appears To Be Fully Valued Now

Stryker (SYK) continues to be a solid medtech play and it started 2022 with an interesting acquisition. This and a fresh year are enough of a reason to update the thesis which dates back to November 2019 when Stryker acquired Wright Medical, when I applauded the long term (dealmaking) track record. Ever since, Stryker has been impacted in a mild way in 2020, offset by a decent recovery in 2021, and 2022 is setting up to be a nice year.

Former Take

Late in 2019 Stryker announced the $5.4 billion purchase of Wright Medical, an expert on extremities and biologics. Since its founding in 1950, the company has gradually risen to become a billion dollar revenue play, derived from shoulder, elbow, wrist, hand, foot, ankle and biologics markets.

Shares of Stryker fell some 3% on the back of the deal announcement at the time, trading around the $200 mark. That looked like a very fair multiple as the company reconfirmed the $8.20-$8.25 per share earnings guidance for 2020, translating to a 24-25 times earnings multiple. This is a steep multiple, but given the steady growth, stable operations and dealmaking track record, it seemed fair. After all, shares have risen a factor of 1,000 times in about four decades’ time.

The cautious reaction from Stryker’s investors was in part the result of a more than 6 times sales multiple being paid for Wright, as the company was more or less breaking even. Stryker traded around 5.5 times sales while it was very profitable of course, and investors had some doubts about the later pay-off of the deal.

In terms of modeling, I believed that Stryker would double net debt to some $11.3 billion for a still manageable 2.9 times EBITDA multiple based on estimated EBITDA of around $3.9 billion.

Finding real appeal to buy this player at 20 times earnings, I saw real appeal if shares were to fall to the $170 mark, levels which shares did not hit with exception to the initial downfall induced by the pandemic.

Continued Improvements

Early in 2020, Stryker announced its annual results for the year 2019. Revenues rose more than 9% to $14.9 billion, almost entirely the result of organic growth, with adjusted earnings of $8.26 per share coming in a penny above the high end of the guidance.

Growth was supported by all the three divisions of the business. MedSurg, the largest division within the company, reported 9% sales growth to $6.6 billion. Orthopedics sales were up a mere 5% to $5.3 billion and a 20% increase in neurotechnology & spine revenues was spectacular with that segment contributing some $3 billion in sales. The company guided for 2020 sales growth around 7% (as the Wright deal has not closed yet) and earnings of $9.10 per share, plus or minus ten cents.

The delay in the timing of the Wright purchase was comfortable as the pandemic impacted the results as well of course. As the deal only closed in November 2020, it gave Stryker quite some time to deleverage the balance sheet ahead of deal closure. Early in 2021, the company reported a 3% fall in full year sales to $14.4 billion, albeit that growth has returned in the fourth quarter of the year already.

Adjusted earnings per share fell 10% to $7.43 per share despite the anticipated increase in earnings albeit that real growth was reported already in the fourth quarter. With the company guiding for 9% sales growth in 2021 and earnings of $9 per share, investors were comforted again, trading at $240 at the start of the year. Net debt stood at $10.2 billion at the end of the year, a billion less than the pro forma number at the time of the deal announcement.

After a stronger first and second quarter, the company hiked the earnings guidance a bit, yet the resurgence of the pandemic hampered growth with 2021 sales now seen up 7-8%, with adjusted earnings per share now seen between $9.08 and $9.15 per share, and net debt has been cut to $10.0 billion.

After trading at a high of $280 in 2021, shares now trade at $265 per share, translating to a $100 billion equity valuation, or $110 billion valuation, if we include net debt of $10 billion. This is equivalent to around 6.6 times sales of $16.5 billion, as multiples have expanded to some 29 times earnings, in part because of some accelerated earnings growth seen following the Wright deal over time.

Another Deal

At the start of 2022, Stryker announced its next deal. While Wright still has to deliver on its promises, Stryker has reached a $3.1 billion deal to acquire Vocera Communications (VCRA).

Since its founding in 2000, Vocera has become a leading digital platform in the digital care coordination and communication category. The deal comes at a price, with Vocera set to generate just around $230 million in revenues in 2021 at 13-14 times sales, a multiple more than twice the multiple at which Stryker trades.

Moreover, the deal is set to add just 1.5% to pro forma sales, coming at a valuation equivalent to 3% of Stryker’s, and the business is breaking even at best here. The deal presentation reveals that Stryker reveals significant operating expense synergies as well as sales synergies, but fails to quantify them.

Investors in Stryker have some reservations with shares down 2.5% at the moment of writing in response to the deal, shedding some $2.5 billion valuation on the back of a $3.1 billion deal. This clearly indicates that investors are not too pleased with the dealmaking which does not contribute after Wright is not accretive yet as well.

Concluding Remarks

Given that Stryker has two deals which still have to contribute, on top of solid organic growth rates, I am comfortable to use a $10 per share forward earnings number, albeit that leverage will jump to $13.1 billion here. This results in a full leverage ratio again here.

With shares now trading at $265, I think they trade at a full 26-27 times forward earnings multiple and leverage is high, yet dealmaking could boost earnings growth in the coming years, but that still has to pan out.

Here, I think that Stryker looks fully priced, but still fairly priced, as any drop towards the low $200 mark sound interesting to initiate a position here.