Investment Summary
 

(a) The company has a strong portfolio in terms of medical devices and geographies, which minimizes its risk elements.

(b) The group has reported a robust operational and financial performance historically.

(c) Shares trading near its 52-week low, which makes an excellent opportunity to buy this value stock.

(d) Favourable guidance stated for the fiscal year 2020 with decent sales growth and profit margins.
 

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.

Key Statistics



Top Shareholders


(Source: Thomson Reuters)

Market Positioning


(Source: Interim Presentation, Company Website)

The company is at 4^th position in Hip & Knee Implants market while in sports medicine segment, the company secured 2^nd position. The company is at 2^nd position in the advanced Wound management segment.

Company’s Strategy


(Source: Interim Presentation, Company Website)

The company’s strategy is divided into three parts:

Grow
 

1. The company focuses on achieving the full potential of its portfolio.

2. It transforms the business through enabling technologies.

3. Expanding in high growth segments.

Together
 

1. It strengthens its talent and capabilities for the sustainable growth.
 

Effectively

1. Ultimately becomes the effective best owner.
 

Revenue Segmentation Based on Geographies - FY2019


(Source: Interim Presentation, Company Website)

The company’s revenue grew by 4.4 per cent in the fiscal year 2019 globally with major revenue generated from the US markets. In emerging markets, the Group has witnessed a revenue growth of 16.1 per cent in the fiscal year 2019.

Product Growth- FY2019


(Source: Interim Presentation, Company Website)

In most of its products, the Group has reported a decent growth with Orthopaedics grew by 4 per cent, Sports Medicine, ENT grew by 7 per cent and Advanced Wound Management grew by 2.2 per cent.

Outlook - FY2020


(Source: Interim Presentation, Company Website)

For the fiscal year 2020, the Group expected sales to grow in the range of 3.5 per cent to 4.5 per cent on underlying basis and 4 per cent to 5 per cent on reported basis. The company expected trading profit margin to be slightly above or at the 2019 levels. Tax rate is expected to be in the range of 18.5 per cent to 19.5 per cent.

Industry Overview

With financial sustainability, care delivery, patient centricity, digital transformation, and regulatory compliance at the top of the agenda, health care sector leaders need to collaborate with all stakeholders—both within the health care ecosystem and those in converging industries - as they look to shape the future of health care and establish a sustainable smart health community. Global Health Care spending continues to increase dramatically and is projected to reach around $10 trillion by 2022.

Recent News

On 5^th March 2020, the company announced that Rick Medlock will join the Group as a Non-Executive Director with effect from 9^th April 2020. He will join the Board and Audit Committee.

On 5^th March 2020, the company announced that its CFO, Graham Baker, had resigned from the Group. He will leave the company on 30^th April 2020.

Financial Highlights – Financial Year 2019


(Source: Preliminary Report, Company Website)

On an underlying basis, the company’s revenue increased by 4.4% to $5,138 million as compared with the previous year (2018: $4,904 million), while reported revenue surged by 4.8% which includes a foreign exchange headwind of -220bps and 260bps benefit from acquisitions. All international regions and franchises positively contributed to growth, led by Emerging Markets (16.1%) and Sports Medicine & ENT (7.0%). Including impact of dilution from acquisitions, the trading profit margin stood at 22.8% in FY19, while operating profit margin was at 15.9% in the same period. The adjusted earnings per share (EPS) increased by 1% at 102.2 cents (2018: 100.9 cents). Basic EPS was 68.6 cents in FY19 (2018: 76.0 cents), reflecting the effect of acquisitions accomplished in the year and restructuring charges related to the APEX (Accelerating Performance and Execution) programme. In FY19, the cash generated from operations stood at $1,370 million, an increase from the previous year (2018: $1,108 million). The full-year dividend per share rose by 4% to 37.5 cents.

In 2019, the company completed the five acquisitions in higher-growth segments. In January 2020, the company has acquired Tusker Medical for securing complementary and innovative ENT technology.

Key Performing Indicators


(Source: Interim Presentation, Company Website)

The company witnessed consistent growth in its revenue and trading profit. Adjusted earnings per share has grown from 85.1 cents in FY2015 to 102.2 cents in FY2019, giving growth of approx. 5 per cent on CAGR basis. Dividend also grew with a CAGR of 5 per cent during the FY2015 to FY2019.

Financial Ratios

 

The reported EBITDA margin in FY19 was 30.10 per cent against the industry median of 22.20%. The reported operating margin was 15.90 per cent for the FY19. Net margin reported was 11.70 per cent for the fiscal year 2019, higher from the industry median of 10.9%. Return on equity for the same period stood at 12 per cent. On the liquidity front, Smith & Nephew Plc current ratio stood at 2.06x. On leverage front, the debt-equity ratio of the Smith & Nephew Plc’s was 0.40 i.e. the company is more leveraged than the industry with debt-equity ratio of 0.23.

Share Price Performance


Daily Chart as on 12^thMarch 2020, before the market closed (Source: Thomson Reuters)

On March 12, 2020, at the time of writing (before the market close, at 10:18 AM GMT), Smith & Nephew Plc shares were trading at GBX 1,393.50, down by 7.70 per cent against the previous day closing price. Stock's 52 weeks High and Low are GBX 2,023/GBX 1,367.50. Stock’s average traded volume for 5 days was 3,942,435.60; 30 days – 2,594,748.90 and 90 days – 2,105,250.91. The group’s stock is reflecting lower volatility as against the benchmark index based on the company’s beta of 0.59. The outstanding market capitalisation was around £13.17 billion, with a dividend yield of 1.82 per cent.

From the technical standpoint, 14 days-Relative Strength Index of the stock is hovering near the oversold zone, which is strengthening the upside move.

Valuation Methodology

Method 1: EV to EBITDA Approach (NTM)



To compare Smith & Nephew Plc with its peers, EV/EBITDA multiple has been used. The peers are Spire Healthcare Group Plc (NTM EV/EBITDA was 11.46), Consort Medical Plc (NTM EV/EBITDA was 10.66) and Convatec Group Plc (NTM EV/EBITDA was 13.47). The Average of EV/EBITDA (NTM) of the company’s peers was 11.87x (approx.).

Method 2: Price to Earnings Approach (NTM)



To compare Smith & Nephew Plc with its peers, P/E multiple has been used. The peers are NMC Health Plc (NTM P/E was 6.32), GlaxoSmithKline Plc (NTM P/E was 13.05), EKF Plc (NTM P/E was 17.61), Convatec Group Plc (NTM P/E was 17.78), Galencia AG (NTM P/E was 22.14), Grifols SA (NTM P/E was 22.64) and Alcon AG (NTM P/E was 26.50). The average of P/E (NTM) of the company’s peers was 18.60x (approx.).

Valuation Metrics



(Source: LSE)
As on 28^th February 2020, the Price to Earnings ratio of the Smith & Nephew Plc’s was around 32.40which was lower as compared with the industry which shows that the company is underpriced than the respective industry.

Smith & Nephew V/S FTSE-100 Price – 1 Year


(Source: Thomson Reuters)

In the last one year, Smith & Nephew Plc share price has delivered negative 5.88 per cent return as compared to negative 22.50 per cent return of FTSE-100 index, which shows that the stock has outperformed the index during the last one year.

Dividend Yield


(Source: Thomson Reuters)

Smith & Nephew Plc has a dividend yield of 1.93 per cent which is slightly lower than the industry dividend yield of 2.07 per cent and in line with the sector dividend yield of 1.93 per cent.

Smith & Nephew V/S Industry V/S Sector – 1 year


(Source: Thomson Reuters)

In the last one year, Smith & Nephew Plc share price increased by 3.01 per cent which is higher than the industry growth rate of 2.55 per cent and lower than sector growth of 3.67 per cent.

Smith & Nephew Total return - 1 year


(Source: Thomson Reuters)

In the last one year, Smith & Nephew Plc has delivered a total return of 4.80 per cent while the FTSE All share index has delivered a total return of negative 12.25 per cent.

Growth Catalyst

In 2020, the underlying revenue growth will be in the range of 3.5%-4.5%, while the company’s reported revenue expected to be in the range of approximately 4%-5% in 2020. Trading profit margin projected to be at or marginally higher than that attained in 2019 after absorbing foreign exchange headwind, increase in the research & development and acquisition-related dilution. Tax rate for 2020 expected between 18.5% and 19.5%.  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, has 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. The Group is also affected with the outbreak of Coronavirus. However, the company expects COVID-19 outbreak situation would normalise early in Q2 FY2020.

Conclusion
In the financial year 2019, the company has enhanced underlying revenue growth of 4.4 per cent, the best for some years, has driven Group sales above 5 billion US dollar for the first time in Smith & Nephew PLC’s history. At the same time, the company continued investing to drive mid-term growth, both increasing the research and development spend, and also expertise through acquisitions and bringing in innovative technologies. Within these, the group will emphasis on delivering a consistent and outstanding client experience, continuing to improve the operational efficiency and agility, and maximising the impact from the increased investment in innovation.

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 5 years (FY14 - FY19), the company’s net income surged from USD 501 million in FY14 to USD 600 million in FY19. Compounded annual growth rate (CAGR) stood at 3.67 per cent.

Based on the decent prospects and support from the valuation as done using the above two methods, we have given a “BUY” recommendation at the current price of GBX 1,367.50 (as on 12th March 2020 at 8:48 AM GMT) with lower-double digit upside potential based on 11.87x NTM EV/EBITDA (approx.) on FY20E EBITDA (approx.) and 18.60x NTM Price/Earnings (approx.) on FY20E earnings per share (approx.).
 
 
*All forecasted figures and Peers information has been taken from Thomson Reuters.

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