Business Overview

Smith & Nephew PLC (LON:SN.) is a diversified advanced medical technology company, which holds market-leading positions in advanced wound management, trauma and extremities, sports medicine, and hip and knee implants. The operations of the group are differentiated in three operating segments, namely Sports Medicine & ENT, Orthopaedics & Trauma and Advanced Wound Management, with the aim to simplify and improve the operating model. The company has operations in over 100 countries globally and support healthcare professionals by manufacturing, developing, selling and marketing medical devices and services. The company’s services and products comprise AET (Arthroscopic Enabling Technologies), Knee Implants, Advanced Wound Bioactives, Trauma & Extremities, Sports Medicine Joint Repair, Advanced Wound Devices, Advanced Wound Care, Hip Implants, and Other Surgical Businesses. The company’s franchise related to Sports Medicine Joint Repair offers surgeons a variety of technologies, instruments and implants required to operate joints’ minimally invasive surgery, degenerative conditions of the knee, shoulder and hip, and repair of soft tissue injuries. The company’s AET franchise provides a range of invasive surgery-enabling devices and systems. The company’s Trauma & Extremities franchise provides support and solutions to healthcare professionals and surgeons to correct bone deformities, treat arthritis, heal soft tissue complications and stabilize severe fractures.

The current Chief Executive Officer is Roland Diggelmann and was appointed on 1^st November 2019 as CEO. Graham Baker holds the responsibilities of the Chief Financial officer and joined the group in 2017. Catheryn O'Rourke holds the responsibilities of Chief Legal and Compliance Officer.

Key Statistics



Top Shareholders

  

Recent News

On 4th November 2019, Smith & Nephew announced that the Chief Executive Officer of the group, Roland Diggelmann, has been appointed as Director of the Board of Accelerate Diagnostics Inc (AXDX). AXDX is listed on NASDAQ.

Trading Update

On 31^st October 2019, Smith & Nephew announced the trading update for the third quarter ended 28 September 2019. On an underlying basis, the company’s revenue increased by 4 per cent to $1,246 million in Q3 FY19 as compared with the corresponding period of the last year, due to an increase in all three franchise. The company’s reported growth of 6.5 per cent includes a foreign exchange headwind of 140bps and a benefit from acquisitions of 390bps. The Orthopaedics showed an increase of 3.4 per cent in revenue, continuing the momentum established in the H1 FY2019. The company’s Sports Medicine & ENT showed good growth in the H1 and had shown a growth of 6.9 per cent in revenue for the period. The Advanced Wound Management showed a growth of 2.1 per cent in revenue, the growth in the revenue stood higher than Q2 data. Following the acquisition, Osiris delivered double-digit growth for the period.

The increased revenue is also driven by the surge in the United States region (up by 9.7 per cent on a reported basis and 2.7 per cent on an underlying basis) and Emerging Markets (up by 15.5 per cent on a reported basis and 16 per cent on an underlying basis).Emerging Markets growth was driven by a robust performance from its Chinese business.

In the first nine months of 2019, the company’s underlying revenue increased by 3.9 per cent, due to the teams across all three global franchises.

The company has updated its Full-year guidance and expected its underlying revenue growth to be in between 3.5 per cent to 4.5 per cent, and trading profit margin is forecasted to be 22.8 per cent (approximately).

Financial Highlights - H1 Financial Year 2019 (29^th June 2019, $, million)

 
 (Source: Interim Report, Company Website)
 
In the first half of the financial year 2019, on an underlying basis, revenue surged by 3.9 per cent, while due to the growth in foreign exchange and benefit from the acquisition, the company’s reported revenue increased by 1.8 per cent to  USD 2,485 million as against USD 2,440 million in the first half of the financial year 2018. In H1 FY2019, gross profit stood at USD 1,837 million versus USD 1,787 million in H1 FY2018. With incremental benefits as compared with the corresponding period of the last year, the ongoing APEX (Accelerating Performance and Execution) programme incurred restructuring costs of USD 48 million in the first half of 2019. The company’s reported operating profit increased to USD 419 million against the reported operating profit of USD 372 million in H1 2018, while the operating margin stood at 16.8 per cent for the period. The company’s trading operating profit increased to USD 532 million against the trading operating profit of USD 507 million in H1 2018, while the operating margin stood at 21.4 per cent for the period. The reported PBT (profit before tax) stood at USD 383 million in H1 FY2019 versus a PBT (profit before tax) of USD 341 million in H1 FY2018. The PAT (profit after tax) attributable to shareholders stood at USD 309 million versus USD 274 million in the first half of the financial year 2018. Basic earnings per share were reported at 35.3 cents, an increase from the previous year and adjusted earnings per share (‘EPSA’) rose by 5 per cent to 45.8 cents in H1 FY2019 against the 43.7 cents in H1 FY2018. The diluted earnings per share stood at 35.2 cents in H1 FY2019 versus diluted earnings per share of 31.2 cents in H1 FY2018.

Key Performance Indicators
 

Revenue

Revenue is the income generated by the company from its normal day to day operations. Smith & Nephew showed increase in the revenue by 3 per cent (on a reported basis), and 2 per cent (on an underlying basis to USD 4,904 million in the financial year 2018 as against USD 4,765 million in FY2017.


Revenue By Market

The company also allocate its revenue on the basis of the market it operates, which include Established Markets and Emerging Markets. The company’s revenue from Established Markets increased by 2 per cent (on reported basis) and 1 per cent (on underlying basis) to USD 4,047 million and its revenue from Emerging Markets surged by 7 per cent (on reported basis) and 8 per cent (on underlying basis) to USD 857 million in the financial year 2018.


Dividend per share

Dividend per share is the amount declared by the company in the form of dividend for ordinary outstanding share. The company’s Dividend Per share was up by 3 per cent (Y-O-Y basis) which reflects an increase in the adjusted earnings of the company and is line with the progressive policy opted by the company.


Trading Profit
In the financial year 2018, the company’s trading profit stood at USD 1,123 million, an increase of 7 per cent year-on-year basis. The company’s Trading profit margin was at 22.9 per cent and increased by 90 bps driven by cost control and improved trading performance.

Financial Ratios
 
 

The reported gross margin in H1 FY2019 was increased by 0.7 per cent to 73.9 per cent against 73.2 per cent reported last year for the same period. The reported EBITDA margin of 28.9 per cent for the H1 FY2019 stood higher than the industry median of 21.2 per cent. The reported operating margin in H1 FY2019 increased by 1.7 per cent to 16.9 per cent from 15.2 per cent reported last year for the same period. The reported Pretax margin of 15.4 per cent for the H1 FY2019 stood higher than the industry median of 11.1 per cent. Net margin reported was 12.4 per cent for the H1 of the financial year 2019, reflecting an increase of 1.2 per cent when comparedwith last year data for the same period. Return on equity for the H1 of the Financial year 2019 stood at 6.3 per cent, which stood higher than the industry median of 5.1 per cent. On the liquidity front, Smith & Nephew Plc’scurrent ratio was higher than the industry median of 1.91, reflecting sufficient current assets to pay its short-term obligations. On leverage front, the debt-equity ratio of the Smith & NephewPlc’swas 0.44x, which was higher as compared to the industry median of 0.26x, reflecting that the company is more leveraged as compared to its peers.

Share Price Performance

Daily Chart as at December-05-19, before the market close (Source: Thomson Reuters)

On December 5, 2019, at the time of writing (before the market close, at 12:30 PM GMT), Smith & NephewPlc shares were trading at GBX 1,688.00, up by 1.63 per cent against the previous day closing price. Stock's 52 weeks High and Low are GBX 1,998.40/GBX 1,383.00. Stock’s average traded volume for 5 days was 1,445,589.00; 30 days – 2,245,202.23 and 90 days – 2,104,633.44. The average traded volume for 5 days was down by 35.61 per cent as compared to 30 days average traded volume. The company’s stock beta was 0.41, reflecting lower volatility as compared to the benchmark index. The outstanding market capitalisation was around £14.41 billion, with a dividend yield of 1.70 per cent.

Valuation Methodology
Method 1: Price to Earnings Approach (NTM)



To compare Smith & NephewPlc withits peers, Price/Earnings multiple has been used. The peers are Boule Diagnostics AB(NTM Price/Earnings was 32.56), Lonza Group AG(NTM Price/Earnings was 26.41), EKF Diagnostics Holdings Plc(NTM Price/Earnings was 21.66), Spire Healthcare Group Plc(NTM Price/Earnings was 21.39) and ConvaTec Group Plc(NTM Price/Earnings was 20.74). The average of Price/Earnings (NTM) of the company’s peers was 24.55x (approx.)

Method 2: Price to Cash Flow Approach (NTM)


To compare Smith & NephewPlc with its peers, Price/Cash Flow multiple has been used. The peers are Consort Medical Plc(NTM Price/Cash Flow was 27.63), Reckitt Benckiser Group Plc(NTM Price/Cash Flow was 14.66), Sonova Holding AG(NTM Price/Cash Flow was 18.90), ConvaTec Group Plc(NTM Price/Cash Flow was 17.64) and Spire Healthcare Group Plc(NTM Price/Cash Flow was 15.50). The Average of Price/Cash Flow (NTM) of the company’s peers was 18.86x (approx.)

Growth and Risk Assessments

The company keeps on launching new platforms and upgrade the old products and services to become one of the market leaders in the healthcare market. The company, through its wide-ranging scope, had accelerated growth organically and through acquisitions. The company with the use of modern technology like 3D printing has significantly reduced the cost for the porous implant, which is generally complex and expensive to manufacture. The group is exposed to the effects of political and economic risks, including the impact of Brexit, as the market expects macro-economic uncertainty or downturn in the UK economy as a result of Brexit. Global political uncertainty regarding trade policy also poses a risk for the group, including protectionist measures and regulation or legislation in local markets

Conclusion
In the third quarter of the financial year 2019, the company recorded a decent performance. The company has raised the full year 2019 guidance by 50bps and anticipates underlying revenue growth in the range of 3.5 per cent to 4.5 per cent. While the reported revenue growth rate is anticipated to be in the range of 3.9 per cent to 4.9 per cent. The company updated the financial 2019 guidance and expects its trading profit margin to be approximately 22.8 and continues to anticipate the tax rate on trading results for 2019 to be in the range of 19%-21%.  

The company has acquired the Centrix, Osiris, Leaf, Brain Lab OJR and Atracsys, which will help in global expansion and will result in the operational excellence. The company has maintained a progressive dividend policy, which indicates an increase in the underlying earnings. The company is focusing on higher growth markets, through M&A and has achieved a significant growth in the past.

Over the course of 4 years (FY14 - FY18), the company’s net income surged from USD 501 million in FY14 to USD 663 million in FY18. Compounded annual growth rate (CAGR) stood at 7.26 per cent.

Based on the decent prospects, present trading levels as opposed to the ones witnessed during the last couple of months and support from the above valuation methodologies in consideration of changing dynamics and defensive business of the company, we have given a “BUY” recommendation at the closing price of GBX 1,661 (as on 4^th December 2019) with high single-digit upside potential based on 24.55x NTM Price/Earnings (approx.) on FY19E earnings per share (approx.) and 18.86x NTM Price/Cash Flow (approx.) on FY19E cash flow per share (approx.).
 
 
*All forecasted figures and peers have been taken from Thomson Reuters. Currency exchange rate taken for 1 USD = 0.7611 GBP.
*The “Buy” recommendation is also valid for the current price as covered in the report (as on 5^th December 2019).

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