Key Investment Highlights
 

1. Smith & Nephew Plc (LON: SN.) hold market-leading positions in advanced wound management, trauma and extremities, sports medicine, and hip and knee implants.

2. The group’s focus is to bring innovation capabilities to market and provide a wider range of distinctive products for the clients.

3. SN. has operations in over 100 countries globally and support healthcare professionals by manufacturing, developing, selling, and marketing medical devices & services.

4. Recently, the group unveiled collaborations with other companies to leverage the global experience and achieve the best outcome.

5. The company has developed NAVIO, Brainlab Buzz, Brainlab KNEE3 and Brainlab HIP, which used Robotics for better surgeries with minimal risk.

6. The group is identified as a market leader in developing advanced techniques and medicines in Wound Management and Orthopaedic Reconstruction.

7. Recent acquisition (completed in January 2020) of Tusker Medical will bolster the capability in the ENT (Ear, Nose and Throat) segment.

8. The group is strategizing towards digital surgery, robotics and machine learning capabilities for sustainable growth.

9. SN. has implemented strong cost control measures, which will result in a decent operational performance with a robust balance sheet and adequate liquidity for the period.

10 The company is confident towards its business model and management team to tackle the uncertain times.
 

Smith & Nephew PLC (LON: SN.) is providing a dividend to shareholders since 1937 and undergone several leadership changes recently, while it is diligently accelerating the portfolio growth and creating synergy through accretive opportunities. 

Smith & Nephew PLC is a FTSE 100 listed medical technology company with global operations. The Group was established in 1856 in Hull, United Kingdom. Currently, it operates in over 100 countries with more than 17,500 employees across its three global franchises, namely Advanced Wound Management, Orthopaedics and Sports Medicine & ENT (Ear, Nose and Throat) and generated USD 5.1 billion in annual sales in 2019. The Group is focussed on five strategic priorities – expanding the established markets, continuous innovation, accelerating growth in emerging markets, supporting organic growth with acquisitions and improving the operating model. It has manufacturing facilities in several countries, including Canada, USA, UK, Switzerland, Germany, China, Costa Rica and India. It became a constituent of LSE (London Stock Exchange) on 13^th August 1951.


(Source: Company Website)

Segments at a Glance
 

1. Advanced Wound Management: Comprises a portfolio of products to solve the complex clinical needs.

2. Orthopaedics & Trauma: Comprises a range of knee and hip implants to replace damaged, worn or diseased joints. It also provides trauma products needed to stabilize bone deformities and fractures.

3. Sports Medicine and ENT: Provides advanced instruments and products to remove or repair soft tissue.
 

Geographically, it differentiates revenue into the United States, Emerging markets and other established markets.

Key Statistics



Progress of Key Performance Indicators in Non-Financial Aspect in 2019
 

1. Provided over 110,000 instances of training to surgeons and nurses globally.

2. APEX programme yielded efficiency savings of USD 80 million.
 

(Source: Presentation, Company Website)

Significant Developments of 2020
 

1. 5^th May 2020: The Group entered a partnership with National Medical Billing Services for RCM (revenue cycle management) solution to ASCs (Ambulatory Surgery Centers) across the United States.

2. 5^th May 2020: The Company signed an agreement with Fiagon to distribute its ENT portfolio across the Asian Pacific markets.

3. 9^th April 2020:Bob White joined the Board of Smith & Nephew PLC from 1^st May 2020, as a Non-Executive Director. Further, the Group announced, Anne-Francoise Nesmes will join the management by 3 August 2020, as new Chief Financial Officer and as an Executive Director to the Board.

4. 2^nd March 2020:The Group announced the cancellation of 649,529 ordinary shares (US 20 cents each), which was previously held in Treasury.
 

Top Shareholders

 

Q1 Trading Update FY2020 and Actions Taken to Mitigate Covid-19 Impact
 

1. On 6^th May 2020, Smith & Nephew released an update of the trading performance for the first quarter ending 28^th March 2020 and measures taken by management to mitigate the risk of coronavirus. The group’s revenue for Q1 FY2020 declined by 7.6 per cent to USD 1,134 million versus USD 1,202 million in Q1 FY2019.

2. The growth on a reported basis dipped by 5.7 per cent for the period, which includes foreign exchange headwind of -1.5 per cent and acquisitions benefit of 3.4 per cent. The performance of all global franchises was impacted by Covid-19.

3. The company is focused on ensuring the health of its employees, customers, sales force and taking measures to make supply chain ready as markets recover.

4. The group managed to achieve savings of around USD 200 million, driven by cost control measures. The company has net debt of USD 1.8 billion with a robust balance sheet and decent liquidity. 

5. The revenue on an underlying basis is expected to be down by 47 per cent in April, and trading in China showed Improvements. The trading for Q2 and H1 FY2020 is expected to be down versus Q2 and H1 data for FY2019. The elective surgeries are making a return to certain markets, including the US.
 

Financial Highlights – Revenue Growth in Financial Year 2019 (31st December 2019)

 
(Source: Investor Presentation, Company Website)
 

1. 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.

2. All international regions and franchises positively contributed to growth, led by Emerging Markets (16.1%) and Sports Medicine & ENT (7.0%). Including the 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.

3. 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.

4. 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.

Financial Ratios: Higher Profitability Margins versus Industry Median

 

The reported Gross Marin, EBITDA margin and Net margin stood at 74.2 per cent, 30.1 per cent and 11.7 per cent, respectively, for the FY2019 and stood higher than the industry median. The Return on Equity of 12 per cent in the financial year 2019 stood lower than the industry median of 15.6 per cent. On the liquidity front, Smith & Nephew Plc’s current ratio was higher than the industry median of 1.56, reflecting sufficient current assets to pay its short-term obligations. On leverage front, the debt-equity ratio of the Smith & Nephew Plc’swas 0.40x, which was higher as compared to the industry median of 0.18x.

Share Price Performance


Daily Chart as on 7^th May 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On May 7, 2020, at the time of writing (before the market close, at 10:22 AM GMT+1), Smith & Nephew Plc shares were trading at GBX 1,633.00, up by 0.71 per cent against the previous day closing price. Stock's 52 weeks High and Low are GBX 2,023.00/GBX 1,055.01.

Bullish Technical Indicator

From the technical standpoint, its shares were trading well above its short-term support level of 20-day simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further.

Valuation Methodology

Method 1: Price/Earnings Approach (NTM)



To compare Smith & Nephew Plc with its peers, Price/Earnings multiple has been used. The peers are Carl Zeiss Meditec AG (NTM Price/Earnings was 45.40), EKF Diagnostics Holdings Plc (NTM Price/Earnings was 25.29), ConvaTec Group Plc (NTM Price/Earnings was 22.47), Reckitt Benckiser Group Plc (NTM Price/Earnings was 21.38) and GlaxoSmithKline Plc (NTM Price/Earnings was 14.49). The Average of Price/Earnings (NTM) of the company’s peers was 25.80x (approx.).

Method 2: Price to Cash Flow Approach (NTM)
 


To compare Smith & Nephew Plc with its peers, Price/Cash Flow multiple has been used. The peers are Biomerieux SA (NTM Price/Cash Flow was 27.20), ConvaTec Group Plc (NTM Price/Cash Flow was 20.35), Reckitt Benckiser Group Plc (NTM Price/Cash Flow was 17.48), GlaxoSmithKline Plc (NTM Price/Cash Flow was 10.67) and Spire Healthcare Group Plc (NTM Price/Cash Flow was 5.30). The Average of Price/Cash Flow (NTM) of the company’s peers was 16.20x (approx.).

Valuation Metrics


(Source: London Stock Exchange)
 
This analysis is a useful technique to decompose the different drivers of ROE. It can be further examined through three financial metrics which are: net profit margin, asset turnover and financial leverage. This analysis helps to deduce whether the company’s profitability, use of debt or assets that are driving ROE.

Smith & Nephew Plc Vs FTSE-100 Index (1 Year)


(Source: Refinitiv, Thomson Reuters)
 
In the last year, Smith & Nephew Plc share price has delivered 3.22 per cent returns as compared to negative 18.93 per cent returns of FTSE-100 index, which shows that the stock has outperformed the index during the last year.

Total Return 5 Years


(Source: Refinitiv, Thomson Reuters)
 
Smith & Nephew Plc has delivered a total return of 59.34 per cent in the last five years versus the total return of FTSE All share of 3.93 per cent for five years period.
 
Industry Outlook

The Global medical device market is expected to reach over USD 612 billion by 2025 from around USD 424 billion in 2018, accelerating at a CAGR of 5.4 per cent (as per the April edition of Fortune Business Insight report). The Global demand is driven by changing lifestyle and health conditions, increasing life expectancy and requirement for innovative medical solutions. The US market is expected to reach USD 300 billion in annual sales by 2030. Moreover, China and India markets have the potential to reach over USD 200 million and 40 million, respectively by 2030, since diabetic patients are rising at an alarming rate. However, the industry also faces several pressures such as complex regulatory procedure, Geo-political factors and competition. 

Growth Prospects and Risk Assessment

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. 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 by the outbreak of Coronavirus. However, the company expects COVID-19 outbreak situation would normalise early in Q2 FY2020.

Business Outlook Scenario

In the Q1 of the financial year 2020, the group’s revenue declined. The revenue on an underlying basis is expected to decline in April and further in Q2 FY2020. 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.


(Source: Company Website, Investor Presentation)

As per the annual report of Smith & Nephew Group, the Group caters USD 38 billion of the market through its product segments, out of the industry (medical device and supplies segment of the global healthcare) of over USD 400 billion.

To tap the market opportunities, the Smith & Nephew Group is moving forward with the following priorities. Firstly, it is supporting the development of ambulatory surgery segment in the US, several product launches, and expanding presence in emerging markets. Secondly, it is focusing on technological advancement and innovation. For example, it has completed the acquisition of Tusker Medical in January 2020, which will enhance its capability in the ENT segment. Thirdly, it targets to bring operation efficiency with optimal facility footprint, lean manufacturing approach and developing an efficient supportive infrastructure.

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 emphasize 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 operational excellence. The company is focusing on higher growth markets, through M&A and has achieved significant growth in the past.

Over the course of 3 years (FY16 - FY19), the company’s revenue surged from USD 4,669 million in FY16 to USD 5,138 million in FY19. Compounded annual growth rate (CAGR) stood at 3.24 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 1,620.50 (as on 7^th May 2020, before the market close at 8:00 AM GMT+1), with lower-double digit upside potential based on 25.80x Price/Earnings (approx.) on FY20E earnings per share (approx.) and 16.20x NTM Price/Cash Flow (approx.) on FY20E cash flow per share (approx.).

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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