Stryker - getting interesting again

Stryker (SYK) looks to be finishing its 6 month consolidation, and looks to be ready to break out again, if the stock can move above $72 on volume over the near future.



Technically, SYK touched $70 per share in late April, right around the date of its first quarter '07 earnings report and then touched $70 again on August 15th. We were trying to accumulate the stock under $60 but during this market correction SYK never traded below $63 and then for only a brief period of time.



Stryker is an exceptional company: a leader in orthopaedic surgical products and hospital beds, SYK has a compounded annual earnings growth rate of 25% for the last 30 years, with a pristine balance sheet, and very healthy cash flow. While the stock has been stuck in a trading range for the past 6 months it only recently broke out of a 2.5 year consolidation which saw SYK trade between $55 at the highs and the low $40's near the bottom between July '04 and late 2006. Thus even with the breakout above $57 in late '06, the stock hasn't acted like the typical growth stock such as an AAPL or RIMM.



Part of the problem could be that SYK sports the "large-cap growth" moniker, which is an asset class that continues to be out of favor these days, despite the litany of guru's and prognosticators on CNBC telling viewers how attractive the large-cap sector, and large-cap growth in particular, remains. Another reason for the underperformance is that healthcare despite its supposedly favorable demographics, is a sector of the S&P 500 that has underperformed since the March, 2003 bottom. Thus not only is SYK in an unfavorable sector, it is also part of an out-of-favor asset class. (Healthcare - as a sector - has returned just 5% and 6% respectively the last two years within the S&P 500, well short of 2006's 15% return for the S&P 500.)



Fundamentally, SYK continues to grow earnings between 15% - 20% with organic growth between 14% - 16%. While pricing has been challenging the last few years contributing just 1% - 2% to orginic growth, volume continues to grow at mid-teens rates and is expected to continue at that rate for the foreseeable future.



Of the major orthopaedic device makers, i.e. Zimmer, Stryker, Smith & Nephew and Biomet (Biomet has since gone private), Stryker in our eyes continues to be the best of the group. While ZMH sports a higher operating margin than SYK, SYK has a better Return on Invested Capital (ROIC) and a higher return on equity (ROE). In addition, the recent Justice Department investigation which has cast a poor light on the consulting arrangments between the device makers and doctor's, leaves SYK in a somewhat better position according to our industry contacts, since SYK didn't abuse these relationships to the extent others did.

Finally, as a portfolio manager, it is always about the cash flow and free-cash-flow generation: currently over the last three years SYK has had a free-cash-flow yield of between 7% - 14% which is pretty extraordinary. Currently SYK's 4q trailing free-cash flow as of June 30 '07 was $826 ml on $5.7 bl in 4q trailing revenues for a 14% "yield" on SYK.

Rumor has it SYK is going to be in the market for an acquisition, and they could likely afford to pay cash for it given the cash generation.

To conclude, SYK a wonderful company in an out-of-favor sector and asset class. I'd love to buy it under $60 but watch for the breakout over $71 - $72 to confirm the next move higher. A large acquisition would cause the stock to come down no doubt, but it would present another buying opportunity for sure.

We'll try and get a chart posted to on SYK shortly.

position in SYK, AAPL, etc.