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Smith and Nephew - Engage Surgical acquisition

Laura Hoy, Equity Analyst | 19 January 2022 | A A A
Smith and Nephew - Engage Surgical acquisition

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Smith & Nephew plc Ordinary USD0.20

Sell: 1,058.00 | Buy: 1,059.00 | Change -5.50 (-0.52%)
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Smith & Nephew's announced an acquisition of US-based Engage Surgical for a maximum of $135m, contingent on sales performance. The deal will be financed using existing cash and debt.

Engage owns the only cementless partial knee replacement system available in the US, and should benefit from Smith & Nephew's existing robotics- assisted surgical system. The group highlighted that "the partial knee market is currently worth approximately $300 million in the US", and is expected to grow faster than the total knee market.

The shares were unmoved following the announcement

View the latest Smith & Nephew share price and how to deal

Our view

Smith & Nephew is a medical device maker with the potential to mount an impressive recovery in the year ahead.

The group operates through three segments - Orthopaedics, offering hip and knee replacements, Sports Medicine, a soft tissue repair business, and Wound Management, providing materials to manage injuries and prevent infection. All three were stifled by the pandemic as elective surgeries plummeted and long-term care facilities closed to new patients.

While Smith & Nephew's been struggling against supply chain headwinds, things are starting to normalise. In particular we think there's significant opportunity in the group's Sports Medicine and Orthopaedics businesses. Both were hit by delays from the pandemic.

But demand hasn't gone away, operations have just been delayed - setting the stage for a very strong recovery. And Smith & Nephew will be meeting this wave of demand with a much more efficient business.

High fixed costs meant lower revenue last year weighed on profits. That pushed the group to embark on a restructuring effort designed to lower its overall cost base, optimising the manufacturing network and outsourcing warehousing and distribution. The project will cost around $350m, but save the group $200m per year by 2025.

This was part of the reason operating margins in the first half were 9.2%, compared to 16.9% pre-pandemic. However, excluding restructuring costs and a handful of other one-off expenses, margins were 17.6%.

If it weren't for supply chain issues and the Delta variant's impact, Smith & Nephew would be rolling into 2022 with a budding recovery. But alas the group is expecting underlying margins to be a tepid 18-19%. Coupled with a modest 2.3% dividend yield, the market isn't overly excited. That's reflected with the group's P/E ratio of 18.0, roughly in line with the long-term average.

If the pandemic continues to recede in 2022, the backlog of elective surgeries postponed in 2020 could flood the market. Smith & Nephew, with its new leaner cost base, is in a solid position to capitalise with a relatively strong balance sheet, and net debt roughly 2 times last year's cash profits.

If things continue to normalise it means management has the flexibility to grow its existing portfolio and capture a larger slice of the market but it also gives the group some breathing room if more Covid-related delays crop up. However another year with surgeries markedly depressed could chip away at the group's strong position.

Smith & Nephew key facts

  • Price/Earnings ratio: 18.0
  • 10 year average Price/Earnings ratio: 18.2
  • Prospective dividend yield (next 12 months): 2.3%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

Strategy Update (16 December 2021)

The group is targeting 4-6% organic revenue growth and margins of at least 21% by 2024.

Smith & Nephew also aims to return excess capital to shareholders through a regular annual share buyback scheme, expected to be worth $250-$300m in 2022.

The group expects to continue building out its product portfolio while continuing to focus on manufacturing and supply efficiency. Management will look to re-establish momentum in Orthopaedics and maintain the strong growth that's been seen in Advanced Wound Management and Sports Medicine.

Find out more about Smith & Nephew shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.

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