Streetwise for July 14

Streetwise for Sunday, July 14, 2013

 

 

Streetwise

 

Lauren Rudd

 

Sunday, July 14, 2013

 

Investment Ideas Come From Personal Experiences

 

Peter Lynch wrote in his 1989 best seller, “One Up on Wall Street,” that the Greeks used to sit around and debate the number of teeth a horse has. Somehow they thought that was a better method than actually counting the teeth in a sampling of horses. In a like manner, many investors are currently sitting around and debating whether the markets are going higher or lower, as opposed to actually “counting the teeth” of potential investments.

 

Lynch made another observation. He pointed out that investment opportunities are often derived from your own experiences. I mention this because I want to revisit two companies I wrote about in the past and for which my original interest came about as a result of two knee replacements. Facing an ankle replacement in August, I am once again drawn to subject of “replacement.”

 

Moreover, the adult population over 65 in the United States is forecasted to grow to 71 million by 2030. In developing countries the number is projected to reach 690 million. The two companies Zimmer (ZMH) and Stryker (SYK) are well positioned to take advantage of that demographic.

 

Zimmer manufactures orthopedic reconstructive implants, dental reconstructive implants and spinal implants. It also offers surgical products, including supplies and instruments. Stryker is similar, operating in two business segments, orthopedic implants and medical and surgical equipment.

 

A year ago my 2012 earnings estimate for Zimmer was $5.25 per share, with a 12-month target price of $67 for a gain back then of 13.70 percent. So how did the company do? It turns out that I was a bit light in my earnings projection. Zimmer earned $5.30 per share adjusted and the shares recently closed at $77.20, well above my forecast.

 

So how does the future look for Zimmer? In its first quarter earnings release, Zimmer’s guidance for the year reaffirmed its expectation that full-year revenues for 2013 will increase between 2.5 percent and 4.5 percent on a constant currency basis over 2012. (Constant currency eliminates exchange rate volatility.)

 

Without the constant currency adjustment Zimmer estimates revenue growth of between 1.0 and 3.0 percent. Earnings are projected to be in the range of $5.05 to $5.25 per share on a reported basis and $5.65 to $5.85 on an adjusted basis.

 

Adjusted refers to operating performance results that exclude inventory charges and special one-time items.  Those items include acquisition and integration costs and asset impairment charges related to prior acquisitions, as well as employee termination benefits, consulting and professional fees, and certain litigation matters among others.

 

Zimmer’s intrinsic value using a discounted earnings approach with a 9.1 percent growth rate and a 12 percent discount rate is $90 per share. The more conservative discounted free cash flow to the firm approach yields an intrinsic value of $118. My earnings estimate for this year is $5.80 per share adjusted, with a 12-month target price of $86 for a 12 percent capital gain. There is also an indicated dividend yield of 1.00 percent.

 

Looking at Stryker, my 2012 earnings estimate was $4.10 per share with a 12-month target price of $61, for a 17 percent capital gain. In actuality, Stryker’s earnings were a bit lighter than my estimate, coming in at $4.07 per share, while the shares recently closed at $66.35, well above my forecast.

 

For 2013, Stryker’s guidance calls for constant currency sales growth in a range of 4.0 to 6.5 percent. Excluding the expected impact of foreign currency and acquisitions, projected 2013 sales growth is expected to grow 3.0 to 5.5 percent. Adjusted earnings per share are expected to be in the range of $4.25 to $4.40.

 

The intrinsic value of the shares using the discounted earnings approach with an 8.08 percent growth rate and a 12 percent discount rate is $64. The free cash flow to the firm approach yields an intrinsic value of $108. My earnings estimate for this year is $4.40 per share, with a 12-month target price of $74 for a 12 percent gain. There is also an indicated dividend yield of 1.60 percent.