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Smith & Nephew: developed markets stronger, emerging markets slow

Charlie Huggins | 4 February 2016 | A A A
Smith & Nephew: developed markets stronger, emerging markets slow

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Smith & Nephew plc Ordinary USD0.20

Sell: 1,295.50 | Buy: 1,296.50 | Change 1.50 (0.12%)
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Smith & Nephew has announced fourth quarter and full year results. Q4 revenue was up 5% on an underlying basis, a slight acceleration on the +4% reported in Q3. Established Markets (+6%), delivered the best quarterly performance since 2012, but emerging markets continued to slow. Underlying sales in these regions grew 2% in Q4, compared with +8% in Q3 and +14% in Q2. As a dollar reporter, Smith & Nephew is battling significant foreign exchange headwinds, which are expected to weigh on margins in 2016. The shares were broadly flat in morning trading.

FY15 highlights (underlying basis unless stated)

  • Full year revenue rose 4%. Reported growth was flat after -8% currency and +4% acquisition impacts. Trading profit margin rose by 80 basis points to 23.7%.
  • Revenue grew 5% in the US, 1% across Other Established Markets and 11% in Emerging Markets. China slowed significantly in H2 and growth here is expected to remain below previous levels in the near-term.
  • Revenue growth was broadly balanced across Advanced Wound Management (+6%), Sports Medicine, Trauma & Other (+4%) and Reconstruction (+3%).
  • Adjusted earnings per share was 85.1 cents, up 2%.
  • Full year dividend lifted by 4% to 30.8 cents per share.

Outlook

Smith & Nephew expects further underlying revenue growth in FY16. However, the company anticipates currency pressures will impact trading profit margins by -120 basis points, at current exchange rates. Without this currency impact the group would have expected margins to reach or exceed 24% in 2016.

Our view:

Smith & Nephew is facing significant currency pressures, which will weigh on margins in FY16; while sales to emerging markets (China in particular) have slowed sharply on the back of an economic slowdown in these regions. These issues aside, the underlying business is performing well.

Recent acquisitions, combined with investment in research and development, have strengthened the group's product portfolio. This is evidenced by the robust performance in developed markets in Q415, with sales growing at the strongest rate for 3 years.

The group's programme to realise at least $120 million of annual savings is progressing ahead of plan, and has already delivered $100 million of annualised benefits. While currency pressures should prove a temporary drag on margins, the efficiency gains the group is making should represent a permanent benefit.

Ageing populations in the West, combined with improved access to healthcare in the developing world, should provide a favourable demographic backdrop. In China, for example, only 300,000 reconstruction procedures are performed annually, compared with 1.1 million in the US, despite China's population being around four times larger. Therefore, while the group does not expect Chinese sales to improve in the near term, this remains a very attractive market in the long run.

Cash flows are strong and the balance sheet is in good shape, giving Smith & Nephew plenty of ammunition to expand into faster growing categories. The recent acquisition of Blue Belt Technologies takes the group into next-generation robotics-assisted technologies. Deals like this, which increase Smith & Nephew's exposure to innovative treatments, should help to it to maintain pricing power and customer relationships.

The shares trade on a P/E of 17.8x which is around a 10% premium to the long run average, at a time when near term growth prospects are relatively muted. However, we like the direction of travel. We also note that the group is still a potential bid target, given it is the smallest of the four major players in the consolidating medical devices industry (the others being Stryker, Johnson & Johnson and Zimmer).

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.