Smith & Nephew reported a 5.0% increase in first half underlying revenue to $3.0bn. All divisions and regions contributed positively to growth, except emerging markets, where performance was impacted by continued weakness in China.
Trading profit (underlying EBITA) increased by 11.2% to $523mn.
Free cash flow increased from $39mn to $244mn, supported by lower restructuring costs, a fall in capital expenditure and improved profitability. Net debt, including lease liabilities, was $2.7bn.
Full-year guidance remains unchanged, with underlying revenue growth at around 5.0%, and trading profit margin of 19-20%, including a $15–20mn impact from tariffs.
The company increased its interim dividend by 4.2% to 15.0¢ per share and launched a $500mn share buyback.
The shares were up 13.9% in early trading.
Our view
Smith and Nephew’s first half came in better than expected, and the added sweetener of a $0.5bn share buyback was greeted enthusiastically by markets on the day. Full-year guidance remains intact too with the first half sales tracking in-line with targets. Margins will need to step up in the second half if the steer on profits is to be met. Easing comparatives in China should help, although government procurement policy is a risk we continue to monitor. But to get over the line the group also needs to deliver further cost-savings.
The company’s dropped the ball before while trying to execute its turnaround plan, and markets may be unforgiving if it does so again.
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.
An ageing population and growing affluence in emerging markets are both tailwinds for surgical procedure growth. But Smith & Nephew is not just sitting and waiting for the market to drive its sales growth. It's continuing to develop and launch new products, cross-sell its wide product range across its territories, and introduce existing products into new areas of treatment.
We see innovation as its biggest weapon for gaining market share. The group’s negative pressure wound therapy products continue to evolve as management targets a multi-year growth opportunity. Its regenerative therapies for sports injuries are also seeing strong sales momentum.
But the group does face some challenges. Underlying operating margin targets have been kicked down the road several times and are materially behind the original recovery plan. High levels of competition in some core product areas and markets could prove to be a further brake on margin growth.
Market forecasts suggest a prospective yield of 2.8%, with a recently announced buyback indicative of growing self-belief by management in its ability to deliver the strategy. The balance sheet looks robust enough to support current pay out levels but there can be no guarantees.
The valuation is some way below the long-term average, and towards the bottom end of its peer group. Shareholders could therefore be rewarded if management can continue turning the ship around, but with plenty of work left to do, investors should be willing to accept some downside risk.
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.
Smith & Nephew’s management of ESG risks is strong according to Sustainalytics. 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.
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