When adjusted for an additional day in the first quarter last year, Smith & Nephew’s underlying sales grew by 4.7% to $1.5bn.
All regions and divisions contributed positively although Orthopaedics growth was minimal reflecting a go-slow in US knee replacements ahead of a key product launch later this year.
Full year guidance of around 6% underlying sales growth and 8% for trading profit remains unchanged.
A $0.5bn buyback has been launched to complete within the next 12 months.
The shares were flat in early trading.
Our view
Smith & Nephew’s first quarter sales didn’t raise any major red flags, but further acceleration is required to make full-year guidance, and a new buyback on the day wasn’t enough to excite investors.
The medical device maker 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.
The Orthopaedics division has been a problem child for the group, hampered by a lack of scale. Operational improvements have had some success in overseas markets, and there are some early signs that this can be replicated in the US.
The division’s biggest revenue generator is knee replacements. In the US, this category has been underperforming the wider market as it shifts from older product lines to its next-generation implants. Orthopaedics just posted its strongest quarter in two years, but a key initiative for further near-term success is the launch of the streamlined knee platform (LANDMARK) later this year. We think it’s an exciting opportunity, but also one where investors will want to see quick results.
We see innovation as its biggest weapon for growing its share of a competitive market. In advanced wound care, the group’s negative pressure therapy products continue to evolve as management targets a multi-year growth opportunity. But changes to how much US healthcare providers are prepared to pay for skin substitutes could be a $20-$40mn profit hit this year.
The group also faces some other challenges. Tariffs are expected to dent this year’s results by around $60mn, and while pricing pressure is easing in China, further reductions are expected in some product lines.
There’s a prospective yield of 2.7% on offer, and share buybacks are underway. We see scope for more generous shareholder payouts further down the line if management can hit its $1bn annual free cash flow target by 2028 – though not guaranteed.
That also supports opportunistic acquisitions like the recent takeover of shoulder specialist Integrity Orthopaedics. Smith and Nephew should be able to bring this novel technology to a wider audience, but the investment required to do so is going to be a further drag on profits this year.
As it stands, Smith & Nephew’s valuation looks broadly reflective of market forecasts. If management can deliver on its medium-term targets, the improved profitability should generate some upside. However, there’s a long way to go if the company is to challenge the higher growth, higher margin names elsewhere in the sector.
Environmental, social and governance (ESG) risk
The healthcare industry is medium/high risk in terms of ESG, depending on subindustry. Across the board, product governance is the most acute risk, with business ethics, labour relations and data privacy also contributing. Providing reasonable access to healthcare as a basic service is also a growing issue, with greater concerns surrounding the social implications of for-profit healthcare companies.
According to Sustainalytics, Smith & Nephew’s management of ESG risks is strong.
The company does not appear to be caught up in any significant controversies. Its strong position in the hip transplant market leaves it exposed to higher litigation risk than some peers. Smith & Nephew addresses this risk via the relevant product safety certifications. There are also strong programmes in place for whistleblowing, and bribery and corruption, as well as an adequate cybersecurity programme. However, the company’s clinical trial programme has scope for improvement, as does its approach towards diversity and inclusion.
Smith & Nephew key facts
All ratios are sourced from LSEG Datastream, based on previous day’s closing values. 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.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by LSEG. 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.