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Will Stryker Give Investors An Early Christmas Gift?

 December 04, 2012 02:44 PM

(By Mani) Stryker Corp. (NYSE: SYK) could announce shareholder friendly measures in the coming days as it has historically announced its quarterly dividend and new share repurchase program during the first week of December.

Last year, on Dec. 7, Stryker increased the quarterly dividend by about 18 percent and authorized repurchase of an additional $500 million in common stock.

Given current U.S. tax uncertainty, Stryker could follow the lead of other U.S. companies and potentially announce a special dividend this week. The company has a dividend yield of 1.6 percent with payout ratio of 23 percent.

"We believe SYK has the current capacity to undertake a $1B+ special dividend. Additionally, SYK management may end up shifting its capital allocation a bit more toward share repurchases and a bit less toward dividends in 2013, should the Bush era tax cuts expire at the end of this year," RBC Capital Markets analyst Glenn Novarro said in a client note.

[Related -Buy This Global Leader In Health Care At A Huge Discount]

Kalamazoo, Michigan-based Stryker is a medical technology company with a range of products in orthopaedics and a presence in other medical specialties. The company's products include implants used in joint replacement, trauma, spinal surgeries etc.

It is worth noting that some sell-side analysts had discussed the potential for a large quarterly dividend increase announcement occurring at the company's Sept. 6 analyst meeting. However, at the analyst meeting, former interim CEO Curt Hartman said that the management team did not feel compelled to make any big change in their approach on dividends. This quashed any near-term investor hopes of an abnormally large increase in the quarterly dividend rate.

[Related -Consensus Analysts' Estimates Provide A Solid Starting Point]

However, several important events have occurred since these comments were made. First, the company announced a new CEO, Kevin Lobo, and the previous interim CEO and CFO, Curt Hartman has resigned. Then, investors have seen a slew of special dividend announcements from large corporations toward the middle to end of November 2012.

"We wonder if these new developments will persuade the board and management to pursue either a special dividend in 4Q12 or shift its capital allocation strategy a bit more toward share repurchases versus dividends in 2013, before potential U.S. tax changes," Novarro said.

A survey of 100 public companies by Markit, a financial information services company, suggested that about 38 percent of companies surveyed reported a likelihood of a special dividend in the fourth quarter of 2012.

Recall that the Bush tax cuts were originally set to expire at the end of 2010, and the market did not see a material increase in special dividends being announced until the November 2010/December 2010 timeframe. Markit estimated that about 74 companies across various industries declared special dividends in the fourth quarter of 2010, up from the normal average of about 31 companies.

"We believe a similar situation is unfolding this quarter, as we have seen a slew of companies start to announce special dividends, really beginning in mid-November 2012," the analyst wrote.

Meanwhile, Stryker has the potential to increase share repurchase activities in the fourth quarter of 2012 as it still has about $595 million left under outstanding share repurchase programs. The company has about $95 million left under the company's 2010 share repurchase program and about $500 million left under its 2011 share repurchase program.

Almost half of the companies surveyed by Markit said they will begin to reallocate cash away from dividends and to share buybacks if dividend taxes move to the 21–25 percent range.

"Accordingly and given SYK's strong balance sheet, we believe SYK management could announce that it will repurchase a larger number of shares than expected in 2013, as it shifts some free cash flow increases away from dividends," Novarro noted.

Meanwhile, Stryker has one of the cleanest balance sheets in medtech space, allowing the company to undertake about potential $1 billion special dividend given the company's large cash and cash equivalents and marketable securities balance and ability to take on additional debt.

"We expect the company to generate ~$1.4B in free cash flow in 2012. We estimate that SYK will pay out ~25% and ~20% of its 2012 free cash flow in dividends and share repurchases, respectively," Novarro said.

The company's current debt to equity ratio is only 21 percent, which is below average for the medtech space, implying that Stryker could choose to take on additional debt.

'Based on these two factors, we believe SYK management has the current capacity to undertake a ~$1B special dividend, which would equate to a special dividend of ~$2.63/share (~4.9% special dividend yield)," Novarro added.



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