Cash and recalls

One of our favourite sectors is the healthcare industry. As global wealth rises so should the amount spent on healthcare, the one thing that can make us live longer and more comfortable. Added to this trend are the ageing baby boomers, who are getting to the age where they require more healthcare.


J&J is one of our favourite stocks in this sector as is Stryker. Stryker are a relatively small company with a market cap of $29.5 billion compared to J&Js $283 billion, they (Stryker) operate in over 100 countries, South Africa included. Their three main divisions are Reconstruction, Medical Surgery and lastly Neurotech & Spine (one of their products is a spinal implant, I didn't know that we could do this yet!).


On to the results, their EPS were down 77% to 18c per share, due to earnings dropping to $70 million from $304 million in the previous comparable period. The reason for the huge drop in earnings is due to the recall of some of their products. The one product being recalled is their replacement hips which started to corrode, not ideal having a corroding hip inside of you! As you can imagine it is very costly having a recall on hips because the cost of the recall includes having a surgery to change hips. Another of their products is a waste management system, from what I understand it is like the suction devise used by dentists except this one is larger and used during surgeries. Both these recalls started in 2012, so they are not unexpected, they are costly though in terms of impact on earnings and reputation damage.


Removing the cost of the call backs, adjusted earnings come in at $1.06 down from $1.09. The lower earnings are due to non-operational expenses and increased shares through options granted. Even though earnings went sideways revenue was up 5.3% to $2.31 billion.

So onto the reasons why we like the stock. The company has a new CEO who has shuffled the management team a bit, which I hope eradicates another product recall. In the health industry when you lose the confidence of your customer it is very hard to get it back, people don't want to take chances with their health. Stryker have been on an acquisition spree to add to their product range and offering. According to one market analyst healthcare providers are starting to reduce the number of supply vendors to get better prices on their bulk purchases, so for Stryker being able to offer a number of products is advantageous.


Stryker have also increased their R&D spend by 16%, which according to my calculations puts the total spend at over half a billion dollars. Being relevant and innovating is key to future growth.


The company generates a large amount of cash, with the current figure sitting at $4 billion (13.5% of current market cap) and they are expected to generate an additional $1.4 billion over the 2014 financial year. All the cash allows them to fund their R&D, further acquisitions and from an earnings perspective further share buy backs. There are still $700 million dollars' worth of share buy backs pending.


Stryker are a global company in an industry that will see significant growth in the coming years. So it is where you want to be, the only worry for me is that there might be another run in with the regulators resulting in more recalls. This is a small risk and not enough to rule out the stock, they are in the correct sector and generate strong cash, so are a strong contender to be one of your health care stocks.