04/22/13 Covered Call Pick: Stryker Corp

Stryker Corp (SKY) is an American-based medical devices company that develops and manufactures orthopedic implants, surgical instruments, and imaging systems. The company is divided into discrete operational units based upon region and specialization. As a whole, the company's specialty are their orthopedic implants (replacement hips, knees, etc) a marketplace in which they are the leader.

Stryker Corp has a market capitalization of $24.61 billion with 380.5 million outstanding shares.

SYK currently pays a $0.265 quarterly dividend for a current yield of 1.6%

With a beta of 0.93, SYK trades with approximately the same amount of volatility as the current market.

Today's Covered Call Pick should instill a sense of deja vu if you were privy to last week's discussion on medical device company Medtronic (MDT). Similar to our motivations for an investment in MDT, SYK is here not only because it is a solid company, but because of the upcoming demographic shifts that will create an increase in medical care spending.

Over the next ten years, the percentage of the population over 65 years old will increase from 13% to more than 16%, topping out to approximately 20% of the population by 2030 if current trends continue. That doesn't sound like a large number, but 7% of the current population (not even considering population growth) is nearly half a billion people. Like we said last week, the one thing that is a fact of nature is that we are all growing older, and as that occurs things will start to break.

When we talk about parts of us breaking (not an appetizing topic for a morning read, we know) the first thing that comes to our minds are bones. This is where SYK excels, as their flagship reconstructive division is where they've made their bones since their 1979 acquisition of Orthopedics Corporation of New Jersey, and 1998's acquisition of Pfizer's orthopedic division. In terms of structural wear-and-tear, our joints take the brunt of the punishment over the course of our lives. Damage to them results in discomfort, pain, and immobilization, so replacements like the ones SYK develop are integral to the life improvement of many aging and overweight people - two rapidly growing demographics.

Beyond the orthopedic division Stryker, like MDT, is also engaged in the neuromodulation field. This growing field is gaining more and more focus by devices companies as technology dealing with the spine and brain find more demand. SYK's neurotechnology division grew by double-digits in 2012, and we believe we will see growth in this area for several years.

The largest issue for a company like SYK, and all the medical device companies, is the "Obamacare" 2.2% excise tax on gross sales of their products. If margins slip and profits decline, this tax will end up severely impacting the bottom line. Finding an upside in this, the tax affects all of SYK's competition as well. As long as SYK continues to deliver with their products. Last quarter's earnings report was positive as SYK beat on both earnings and revenue. The company just recently raised their 2013 estimates for earnings of 6% year-over-year growth, and 3-5.5% revenue growth. The company's board also authorized $405 million worth of common stock buybacks, bringing the total buyback power to $1 billion. SYK continues to make strategic acquisitions to continue their growth in the medical devices marketplace while they continue to innovate new products like mobile-bearing hip replacements. Between acquisitions, innovation, and a solid balance sheet, we believe SYK will be able to weather the near-term challenges it faces. As proof of this, the company has had increasing earnings for the past six years - that includes the 2008-2009 recession. We always like to say, if you can make money in the bad times, you will survive to the good times.

For a Covered Call Strategy on SYK, we're looking at an out-of-the-money Call in order to hold on to the stock. SYK is another one of our "Legacy Stocks", so we want to try and hold on to it in our portfolios. That's why we are aiming for an out-of-the-money Call, even though in the near-term, the stock's technicals show it might be flattening out. We're not looking for immediate profit here, but rather we just want to supplement the dividend yield so we get paid for our commitment to holding the stock for the long term. That is why we are recommending buy SYK and selling the January 2014 $70 out-of-the-money Call.



Scenario:

  • Buy 100 shares of SYK @ $64.19 = $6,419 + Commission ($12.95) = $6,431.95
  • Write 1 SYK January 2014 $70 Call @ $170 - Commission ($8.70) = $161.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns. 


Static Return (Not Called):

(Call + Dividend)/Stock Price   X    (Days/Year)/Days to Expiration

(1.61 + (3*0.265))/64.32      X    (365)/270

5.05% Static Return


If-Called Return:

(Call + Dividend + Strike Price - Stock Price)/Stock Price       X        (Days/Year)/Days to Expiration

(1.61 + (3*0.265) + 70 - 64.32)/64.32       X      (365)/270

16.99% If-Called Return



Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual’s personal investment goals and risk tolerance.

 

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