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Joe Gallinatti Stryker Corporation (SYK) Financial Analysis October 25, 2016

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Joe Gallinatti Stryker Corporation (SYK)

Financial Analysis October 25, 2016

Table of Contents Company History ........................................................................................................................................... 3

Competitors ...................................................................................................................................... 4

Potential Risks ................................................................................................................................ 4

Recent Acquisitions .......................................................................................................................... 5

Balance Sheet ................................................................................................................................................ 6

Income Statement ........................................................................................................................................ 7

Income Statement Analysis .............................................................................................................. 8

Cash Flow Statement .................................................................................................................................... 9

Cash Flow Analysis .......................................................................................................................... 10

Financial Ratios ........................................................................................................................................... 11

Conclusion .................................................................................................................................................. 14

Company History “Stryker’s history is rooted in innovation. When Dr. Homer Stryker, an orthopedic

surgeon from Kalamazoo, Michigan, found that certain medical products were not meeting his

patients’ needs, he invented new ones. As interest in these products grew, Dr. Stryker started a

company in 1941 to produce them. The company’s goal was to help patients lead healthier,

more active lives through products and services that make surgery and recovery simpler, faster

and more effective.

Today, Stryker is a global leader in the medical

technology industry. Company growth is based on an

unparalleled variety of high-quality, innovative products

and services that create cost-effective solutions and

improve people’s lives – which we achieve through the

dedication of our over 27,000 employees globally in 2015.

The spirit of bringing innovation to healthcare

began with Dr. Stryker when he founded the company in 1941 and it continues today. Stryker is

well-positioned to continue serving the worldwide medical community for generations to

come.” (Stryker Website)

Competitors Medtronic PLC is the world's largest standalone

medical technology development company. It

serves hospitals, physicians, clinicians, and

patients. Medtronic PLC was founded in 1949

and is headquartered in Dublin, Ireland.

Abbott Laboratories was founded in 1888 and is

headquartered in Abbott Park, Illinois. Abbott

has a broad range of branded generic

pharmaceuticals, medical devices, diagnostics,

nutrition products, including Ensure, a line of

meal replacement shakes.

Boston Scientific Corporation,developed in 1979, is a worldwide developer, manufacturer and

marketer of medical devices whose products are used in a range of interventional medical

specialties. Primarily known for the development of the Taxus Stent, a drug-eluting stent which

is used to open clogged arteries.

Zimmer Biomet Holdings Inc was founded in 1927 and headquartered in Warsaw, Indiana.

Zimmer Biomet is a global leader in musculoskeletal healthcare.

Intuitive Surgical Inc was founded in 1999, and is the global leader in the rapidly emerging field

of robotic-assisted minimally invasive surgery. They are most known for the da Vinci surgical

system, which features a 3D HD vision system for a clear and magnified view inside the patient's

body. Allows surgeons to perform complex and routine procedures through a few small

openings.

Potential Risks (According to 10-K Report)

Effectively develop and market

products against the products of our

competitors in a highly competitive

industry.

Possible inability to maintain adequate

working relationships with healthcare

professionals.

Macroeconomic developments could

negatively affect our ability to conduct

business in affected regions.

Exposure to exchange rate fluctuations

on cross border transactions and

translation of local currency results

into United States dollars

Recent Acquisitions (Stryker Website)

MAKO SURGICAL CORP.

MAKO has established a compelling technology platform in robotic arm assisted surgery which

Stryker believes has considerable long-term potential in joint reconstruction.

BERCHTOLD HOLDING, AG

Berchtold has provided customer-centric healthcare equipment for over 90 years. Combining with

Stryker Endoscopy’s existing operating room equipment portfolio created a comprehensive, quality-

focused offering equipped to satisfy a wide range of customer needs around the globe.

PATIENT SAFETY TECHNOLOGIES, INC.

The company’s proprietary Safety-Sponge System and SurgiCount 360 compliance software help

prevent Retained Foreign Objects (RFOs) in the operating room, thereby improving patient safety

and reducing healthcare costs. The SurgiCount Safety-Sponge System offers a way to eliminate

unnecessary costs from the healthcare system while improving quality of care.

SMALL BONE INNOVATIONS, INC.

SBi products are designed and promoted for upper and lower extremity small bone indications, with

a focus on small joint replacement. With the addition of the STAR Ankle to the Stryker Foot & Ankle

product portfolio, Stryker comprehensively addresses the broad range of foot and ankle procedures.

CHG HOSPITAL BEDS, INC

CHG designs, manufactures and markets a series of low height hospital beds and related accessories.

Hip arthroscopy is the fastest growing procedure in sports medicine as a result of improved

procedural solutions and growing demand for less invasive solutions. Pivot’s innovative products

complement Stryker’s existing sports medicine portfolio and provide Stryker’s customers with a

comprehensive offering to address the challenges of Sports Medicine procedures.

PIVOT MEDICAL, INC.

Pivot has a platform of innovative instruments and implants, with a focus on hip arthroscopy

procedures to efficiently access and restore the mobility of the hip with minimal incisions. Pivot’s

innovative products complement Stryker’s existing sports medicine portfolio and provide Stryker’s

customers with a comprehensive offering to address the challenges of Sports Medicine procedures

Consolidated Balance Sheets - USD ($) $ in MillionsCommon Size Year to Year % Change

Dec. 31, 2015 Dec. 31, 2014 2015 2014 2015-2014

Current assets

Cash and cash equivalents $ 3,379 $ 1,795 20.80% 10.39% 88.25%

Marketable securities 700 3,205 4.31% 18.55% -78.16%

Accounts receivable, less allowance of $61 ($59 in 1,662 1,572 10.23% 9.10% 5.73%

Inventories

Materials and supplies 304 248 1.87% 1.44% 22.58%

Work in Process 103 88 0.63% 0.51% 17.05%

Finished Goods 1,232 1,252 7.58% 7.25% -1.60%

Total inventories 1,639 1,588 10.09% 9.19% 3.21%

Prepaid expenses and other current assets 564 524 3.47% 3.03% 7.63%

Total current assets 7,944 8,684 48.90% 50.26% -8.52%

Property, plant and equipment

Land, buildings and improvements 687 678 4.23% 3.92% 1.33%

Machinery and equipment 2,043 1,919 12.57% 11.11% 6.46%

Total property, plant and equipment 2,730 2,597 16.80% 15.03% 5.12%

Less allowance for depreciation 1,531 1,499 9.42% 8.68% 2.13%

Net property, plant and equipment 1,199 1,098 7.38% 6.35% 9.20%

Other assets

Goodwill 4,136 4,186 25.46% 24.23% -1.19%

Other intangibles, net 1,794 2,018 11.04% 11.68% -11.10%

Other noncurrent assets 1,174 1,293 7.23% 7.48% -9.20%

Total assets 16,247 17,279 100.00% 100.00% -5.97%

Current liabilities

Accounts payable 410 329 2.52% 1.90% 24.62%

Accrued compensation 637 597 3.92% 3.46% 6.70%

Income taxes 141 333 0.87% 1.93% -57.66%

Dividend payable 142 131 0.87% 0.76% 8.40%

Accrued recall expenses 694 1,593 4.27% 9.22% -56.43%

Accrued expenses and other liabilities 710 751 4.37% 4.35% -5.46%

Current maturities of debt 769 727 4.73% 4.21% 5.78%

Total current liabilities 3,503 4,461 21.56% 25.82% -21.48%

Long-term debt, excluding current maturities 3,253 3,246 20.02% 18.79% 0.22%

Other noncurrent liabilities 980 977 6.03% 5.65% 0.31%

Shareholders' equity

Common stock, $0.10 par value: Authorized: 1 billion

shares, Outstanding: 378 million shares (378 million in

37 38

0.23% 0.22% -2.63%

Additional paid-in capital 1,321 1,252 8.13% 7.25% 5.51%

Retained earnings 7,792 7,559 47.96% 43.75% 3.08%

Accumulated other comprehensive income (639) (254) -3.93% -1.47% 151.57%

Total shareholders' equity 8,511 8,595 52.39% 49.74% -0.98%

Total liabilities & shareholders' equity $ 16,247 $ 17,279 100.00% 100.00% -5.97%

Balance Sheet

Consolidated Statements Of Earnings - USD ($)

shares in Millions, $ in Millions

12 Months

Ended Common Size Year Over Year % Change

Dec. 31, 2015 Dec. 31, 2014 Dec. 31, 2013 2015 2014 2013 2015-2014 2014-2013

Income Statement [Abstract]

Net sales $ 9,946 $ 9,675 $ 9,021 100.00% 100.00% 100.00% 2.80% 7.25%

Cost of sales 3,344 3,319 3,002 33.62% 34.30% 33.28% 0.75% 10.56%

Gross profit 6,602 6,356 6,019 66.38% 65.70% 66.72% 3.87% 5.60%

Research, development and engineering expenses 625 614 536

6.28% 6.35% 5.94% 1.79% 14.55%

Selling, general and administrative expenses 3,610 3,547 3,467 36.30% 36.66% 38.43% 1.78% 2.31%

Recall charges, net of insurance proceeds 296 761 622 2.98% 7.87% 6.90% -61.10% 22.35%

Intangible asset amortization 210 188 138 2.11% 1.94% 1.53% 11.70% 36.23%

Total operating expenses 4,741 5,110 4,763 47.67% 52.82% 52.80% -7.22% 0.02%

Operating income(EBIT) 1,861 1,246 1,256 18.71% 12.88% 13.92% 49.36% -0.80%

Other income (expense), net (126) (86) (44) -1.27% -0.89% -0.49% 46.51% 95.45%

Earnings before income taxes 1,735 1,160 1,212 17.44% 11.99% 13.44% 49.57% -4.29%

Income taxes 296 645 206 2.98% 6.67% 2.28% -54.11% 213.11%

Net earnings $ 1,439 $ 515 $ 1,006 14.47% 5.32% 11.15% 179.42% -48.81%

Net earnings per share of common stock:

Basic net earnings per share of common stock (in

dollars per share)

$ 3.82 $ 1.36 $ 2.66

Diluted net earnings per share of common stock

(in dollars per share)

$ 3.78 $ 1.34 $ 2.63

Weighted-average shares outstanding - in

millions:

Basic (in shares) 376.6 378.5 378.6

Net effect of dilutive employee stock options (in

shares)

4.3 4.3 3.5

Diluted (in shares) 380.9 382.8 382.1

Anti-dilutive shares excluded from the calculation

of net effect of dilutive employee stock options (in

shares)

0 0 0

Income Statement

Income Statement Analysis

Stryker Corp.’s income statement has a Gross Profit Margin that shows a decrease from

66.72% in 2013 to 65.70% in 2014, and then a slight increase in 2015 at 66.38%. Stryker Corp.’s

sales revenue increased just above 7% from 2013-2014 and around 3% from 2014-2015. Their

cost of sales also increased each year with a 10% increase from 2013-2014, which correlates

with the decrease in gross profit margin for 2014, and a slight increase of almost 1% from 2014-

2015.

The operating profit margin follows the same trend as the gross profit margin with a

slight decrease of 1% from 2013-2014 and an increase of about 6% from 2014-2015. The gross

profit for Stryker increases all three years, at an average rate of around 4%. Stryker increases

their R&D expenses each year, with their biggest increase of $78 million coming from 2013-

2014. The largest amount of Stryker Corp.’s expenses comes from their Selling, general and

administrative expense, which is also increasing at an average rate of 2% each year. The recall

charges for Stryker Corp. are substantially high in 2013 and 2014 totaling $1,383 billion for the

2 years, due in large part to thousands of lawsuits of issuing faulty hip/neck devices in 2012.

The settlement agreement for the lawsuits came in 2014, which was the highest value at $761

million. The recall charges decreased $465 million from 2014-2015. The lawsuits are one of the

main causes for the decrease in gross and operating profit margins from 2013-2014. The

operating income is greatly affected by the recall charges with a slight decrease of around 1%

from 2013-2014, but an increase of about 50%

after the settlement from 2014-2015.

Stryker Corp.’s net profit margin suffers a

large decrease of 5% from 2013-2014 and a

tremendous increase of 9% from 2014-2015. The

earnings before income tax have a small decrease

from 2013-2014, but plays a role for the 50%

increase of about $600 million from 2014-2015.

Stryker Corp.’s income taxes had a substantial

increase of over $400 million from 2013-2014 and

a decrease of the same amount from 2014-2015. The effective income tax rate on the earnings

before tax was 17.1%, 55.6% and 17.0% for the 2015, 2014 and 2013. The effective income tax

rate for 2014 included the tax impact of the establishment of their European regional

headquarters and the planned cash repatriation that was executed in 2015. This explains the

great decrease in net earnings and net profit margin from 2013-2014. The illustration above

shows the affect the repatriation had on the net profit margin.

Avg. Effective Tax Rate for 2013 & 2015=17.04

2014-Impact Repatriation W/O

Repatriation EBT 1160 1160

(Mult.):Effective Tax Rate

55.60% 17%

Add: Income Taxes

645 197.20

Net Earnings 515 962.80 Net Profit

Margin 5.32% 9.95%

Consolidated Statements Of Cash Flows - USD ($) $ in

Millions12 Months Ended

Dec. 31, 2015 Dec. 31, 2014 Dec. 31, 2013

Operating activities

Net earnings $ 1,439 $ 515 $ 1,006

Adjustments to reconcile net earnings to net cash

provided by operating activities:

Depreciation 187 190 169

Amortization of intangible assets 210 188 138

Share-based compensation 86 77 76

Gross recall charges 349 940 622

Sale of inventory stepped up to fair value at acquisition 7 27 28

Deferred income tax benefit 87 60 23

Changes in operating assets and liabilities:

Accounts receivable (151) (89) (89)

Inventories (115) (173) (77)

Accounts payable 35 13 1

Accrued expenses and other liabilities 73 92 41

Recall-related payments (1,206) (98) (6)

Income taxes (290) 133 (124)

Other 188 (93) 78

Net cash provided by operating activities 899 1,782 1,886

Investing activities

Acquisitions, net of cash acquired (153) (916) (2,320)

Purchases of marketable securities (1,715) (4,365) (4,558)

Proceeds from sales of marketable securities 4,094 3,636 4,856

Purchases of property, plant and equipment (270) (233) (195)

Net cash provided by (used in) investing activities 1,956 (1,878) (2,217)

Financing activities

Proceeds from borrowings 1,576 1,601 369

Payments on borrowings (2,272) (1,428) (355)

Proceeds from issuance of long-term debt, net 744 986 991

Dividends paid (521) (462) (401)

Repurchase of common stock (700) (100) (317)

Other financing 32 32 13

Net cash (used in) provided by financing activities (1,141) 629 300

Effect of exchange rate changes on cash and cash

equivalents

(130) (77) (25)

Change in cash and cash equivalents 1,584 456 (56)

Cash and cash equivalents at beginning of year 1,795 1,339 1,395

Cash and cash equivalents at end of year 3,379 1,795 1,339

Supplemental cash flow disclosure:

Cash paid for income taxes, net of refunds 497 437 321

Cash paid for interest on debt $ 101 $ 102 $ 88

Cash Flow Statement

Cash Flow Analysis

Stryker Corp.’s cash flow from operating activities is positive all three years, with the

largest number of about $1.9 billion in 2013. However, the operating activities have a

substantial decrease in 2014-2015, due the issuance of large amounts of recall payments and

income taxes in 2014. Stryker Corp.’s net income is positive all three years, with a large increase

in 2015, due to the legal and tax rate matters. Their accounts receivables were increasing all

three years with a increase of $62 million in 2015, while accounts payable are increasing all

three years. Stryker Corp. is consistent with a growth company, in regards to inventories and

sales increasing all three years. The huge decrease in recall-related payments from 2014-2015,

is in correlation to the series of 2012 lawsuits that settled in 2014 that payed more than $1

billion. In 2013 and 2014, there were large amounts of gross recall charges of $620 million and

$940 million that seemed to be unexplained in the 10-K report. The charges are a direct result

as to why the cash provided by operating activities were so high in those two years.

Cash flow from investing is negative and decreasing from 2013-2014, with a tremendous

increase of over $1 billion from 2014-2015, due to taking a large amount of their proceeds from

marketable securities in 2015, while reducing their spending of $2.65 billion to purchase

marketable securities to make recall-related payments. Stryker Corp. had an increase in

acquisitions all three years, with the most spending coming in 2013 of $2.32 billion acquiring

Trauson Holdings Company Limited and Mako Surgical Corp. Stryker Corp.’s CAPEX is increasing

all three years with its largest purchase of $270 million coming in 2015, which is consistent with

a growth company.

Stryker Corp.’s free cash flow is positive all

three years, but is decreasing at a decreasing rate.

Stryker Corp. can finance their purchases of property,

plant, and equipment and acquisitions purchases

internally, except for in 2013 due to large

acquisitions.

Cash flow from financing is positive at $300 million in 2013 and $629 million in 2014, but

significantly negative at a decrease of over $1.5 billion in 2015. Stryker Corp. is increasing their

payments on borrowings each year with their highest in 2015 at around $2.27 billion, which

was an increase of $844 million from 2014-2015. Stryker Corp.’s long term debt is positive each

year at a decreasing rate with its largest amounts in 2013 and 2014 of around $990 million. The

Free Cash Flows

2013 2014 2015 Net Cash From Operating

Activities 1,886 1,782 899

Purchase of property, plant and equipment

(195) (233) (270)

1,691 1,549 629 Acquisitions, net cash

required 2,320 916 153

issuance of long term debt could be a concern for Stryker because of the acquisition and legal

expenses that have recently presented themselves. Stryker Corp. is increasing their dividends

paid to shareholders by 9.8% from 2014-2015 and 15.1% from 2013-2014, while also

repurchasing common stock all three years with its largest of $700 million in 2015. According to

the 10-K Report, Stryker Corp. decided to suspend their share repurchase program through

2016, which is another cause for concern telling investors that they may need more money to

cover their losses. Stryker Corp. seems to be using a conservative financing strategy, due to

dramatically increasing cash over the 3 year period.

Financial Ratios

DuPont Analysis (Traditional) 2015 2014

NPM (Profitability) 14.47% 5.32%

TAT (Efficiency) 0.61 0.56

Financial Leverage 1.91 2.01

ROE 16.91% 5.99%

The net profit margin, of Stryker Corp. has improved dramatically from 2014-2015, due to

the gain on net income that was a result from the decrease of recall payments issued in the

2014 settlement and the income tax on the planned cash repatriation that was executed in

2015. This provides an improvement on the return on equity from 2014-2015, but can also

give someone a misleading representation because of the higher recall payments and

income tax in 2014. Stryker Corp. is also becoming more efficient, shown by the

improvement of the total asset turnover ratio. Stryker Corp. shows all three metric’s

improve from 2014-2015, except financial leverage in 2014-2015. The financial leverage is

decreasing due to the decrease in total assets.

Liquidity 2015 2014

Current Ratio 2.27 1.95

Quick Ratio 1.66 1.49

Free Cash Flow 629 1,549

Net Working Capital 4,441 4,223

Stryker Corp.’s current ratio improved from 2014-2015, although a rough measurement, providing

that Stryker Corp. has the ability to pay off its liabilities with its current assets. The quick ratio is also

W/O Repatriation in 2014

NPM 9.95% TAT 0.56

Fin Lev. 2.01 ROE 11.20%

improving from 2014-2015. The quick ratio does cause concern with the marketable securities

having a deterioration of almost $2.5 billion and an increase in accounts receivable from 2014-2015.

Those accounts are used for quick cash and could lead to conflicts. Free Cash Flow is deteriorating

from 2014-2015, due to the large amounts in recall related payments in 2015. The net working

capital is increasing from 2014-15, which correlates with the current ratio. Overall, there reasons for

concern for Stryker Corp.

Asset Turnovers and Cash Conversion Cycles Asset Turnover Ratios

2015 2014 Total Asset Turnover 0.61 0.56 Fixed Asset Turnover 8.30 8.81 Receivables Turnover 5.77 5.93 Inventory Turnover 2.04 2.09 Accounts Payable Turnover 8.16 10.09

Cash Conversion Cycle

2015 2014 Average Collection Period 60.99 59.33 Days Inventory On Hand 178.90 174.64 Days Payable Outstanding 44.75 36.18 CCC=ACP+DIH+DPO 197.4 199.9

Stryker Corp.’s asset turnover improves from 2014-2015 meaning they are using their assets more

wisely. The fixed asset turnover is deteriorating, due to assets increasing at faster rate than sales.

The receivables turnover is deteriorating implying they are not collecting or utilizing their

receivables, which is represented in the avg. collection period. Their inventory turnover is

deteriorating and becoming more inefficient, while the day inventory on hand ratio is depreciating

by 4 days. Stryker Corp.’s Days payable outstanding is improving by around 8 days from 2014-2015.

This could mean that credit standards are more flexible. The cash conversion cycle is improving,

implying that cash is coming in at faster rate for Stryker Corp.

Interest Finance Coverage 2015 2014

Time Interest Earned 14.77 14.49

Debt to Service 0.36 1.09

Fixed Charge Coverage 8.09 6.71

Cash Flow Adequacy 0.35 1.07

Stryker’s time interest earned is very appealing. The improvement displays that earnings from

operations are able to pay off interest 14x over. The huge amount of deterioration of the debt to

service ratio is 0.73, providing that Stryker’s income is greater than sales, and the sales are more

than the interest. Stryker Corp.’s improvement to in fixed charge coverage gives them more fixed

cash flows to repay debt. The cash flow adequacy is deteriorating by 0.72, which means that Stryker

Corp. is losing the ability to pay off necessary obligations and if their debt obligations were due

today that they would have trouble being able to pay them..

Leverage 2015 2014

Debt to Equity Ratio 0.91 1.01

Debt Ratio 0.48 0.50

Long-term Debt to Capitalization 0.71 0.72

The debt to equity has deteriorated from 1.01 in 2014 to 0.91 in 2015, due to the debt being

decreased around $1billion compared to equity. The debt ratio shows that Stryker Corp.’s debt

deteriorated at a larger rate than total assets with a slight decrease of 0.2 from 2014-2015. Long-

term debt to capitalization ratio proves that Stryker Corp. prefers to finance their business activities

with long-term debt. This is very common during periods with lower interest rates.

Returns The operating assets from 2014-2015 are improving,

while operating liabilities are deteriorating. The net

operating assets show an increase from 2014-2015. The

NOPAT at a given 30% tax rate shows a significant

decrease from 2014-2015, due to a huge difference

from the EBIT, which as a result shows a substantial

increase on RNOA of about 9% from 2014-2015. Stryker shows another increase in non-operating

assets from 2014-2015. The RNOA represents another reason as to why the recall payments and

income tax directly the increase the ROE in from 2014-2015.

2014 2015

Operating Assets 13,387 13,760 Operating Liabilities 4,247 3,431

NOA 9,950 10,329 NOPAT 484 1,408.70

RNOA(NOPAT/NOA) 4.87% 13.64% Add:Non-Operating

Return 1.12% 3.27%

ROE 5.99% 16.91%

Conclusion

Based on the analysis done above, I am confident to say that I believe Stryker to be a risky

investment at this point in time. They are outperforming their industry and show the ability to

increase sales through acquisitions and internal growth, but that doesn’t outweigh company’s

concerns. They have increasing long term debt, the loss of the ability to meet the company’s

obligations through operating income, and the high competition in the market. Most importantly,

the uncertainty with the legal disputes and the recall payments should make an investor nervous.

The 10-K Report states how Stryker is uncertain on how much the lawsuits will actually cost them,

which is now above $2billion. Moreover, the announcement to suspend their share repurchase

program through 2016 is another cause for concern telling investors that they may need more

money to cover their losses.