Smith & Nephew PLC (LON: SN.) - Business to improve with return in elective surgeries

Smith & Nephew is a UK based company that is into the business of medical technology. The medical technology provided by the Company helps in restoration of well being. Smith & Nephew has a global franchise of Orthopaedics, Advanced Wound Management and Sports Medicine & ENT. The Orthopaedics segment provides Hip and Knee Implants that is used to replace diseased damaged or worn joints and robotics-assisted technologies that helps surgeons to correct bone deformities and stabilize severe fractures. Advanced Wound Management supplies products for clinical needs and helps healthcare professionals to get close to the economic consequences of wounds. Sports Medicine & ENT division provides advanced products and instruments for repair or removal of soft tissue. The Company was founded in 1856, and it has a current workforce of over 17,500 people with operations in around 100 countries. The Company is listed on the FTSE-100 index.

(Source: company website)

Growth Prospects and Risk Assessment

Smith & Nephew is committed to innovation, and it has continuously increased its research & development investment. The Company is expanding in the high growth segment with continued merger & acquisition deals, both in products and technology. The Company has a strategy in place that adapts to robotics, software, smart tools and data for improving outcomes. It has launched products such as Intellio Connected Tower, OR30 dual mobility and it achieved regulatory clearance for TKA on CORI.

In Q3 FY20, the Company launched “The Core of Real Intelligence” (CORI) surgical system for unicompartmental and total knee arthroplasty.  CORI is a new generation handheld robotics platform and ideal for ambulatory surgery centres. It has received improved outcomes for patients and surgeons for its CORI surgical system. The Company has launched multiple innovative products, and it would work on the development of robotic-assisted products.

The Company manufactures products that are used in the human body, and therefore patient safety is critical. The regulatory bodies have tightened the quality of products used in manufacturing the devices with a focus on clinical and technical evidence to reduce risk. Defects in design or manufacturing of products could result in a life loss or injury. The failure in obtaining approvals for new or changed technology can put the product at risk. The Company has an increased price pressure from customers and government authorities to sell products at affordable prices, and thus selling products at a lower price amid rising manufacturing costs can impact the margins.

Industry Outlook Dynamics

The medical device segment is growing globally, with disruptive innovation taking place regularly. The robotics and digital surgery ecosystem are building up precision and efficiency for surgeries. The elective surgeries are expected to be back soon; however, the timing in different countries varies. Elective surgeries in China are increasing but are still below the normal volume. In the US, the elective surgery depends on the capacity of the hospital, and in the UK, the elective surgery depends on the urgency. The medical device sector is a stable and growing market. Hip & Knee Implant market is expected to be around USD 14.8 billion, and it grew by 3% in 2019. Advanced Wound Management segment has a market size of USD 9.4 billion, and it increased by about 4%. Sports Medicine market size is close to USD 5.3 billion, and it grew by 5%.

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Smith & Nephew Plc

A Glimpse of Business Segments

Recent Developments

On 20 October 2020, the Company announced the appointment of Katarzyna Mazur-Hofsaess as a Non-Executive Director of Smith & Nephew. Katarzyna is a qualified medical doctor and has a strong track record in senior leadership within the MedTech industry.

On 8 October 2020, the Company announced that it had priced an offering of US$1 billion Notes, which will be due in 2030.

On 29 September 2020, Smith & Nephew announced that it had agreed to acquire the Extremity Orthopaedics business, for a consideration of US$240 million. This business is of Integra LifeSciences Holdings Corporation, which will support the Smith & Nephew’s strategy to invest in higher-growth segments. 

Trading Statement (for the third quarter ended 26 September 2020 (Q3 FY20), as on 29 October 2020)

• The Company saw a significant recovery from the previous quarter (Q2 FY20), with Q3 revenue of $1,200 million.
• On an underlying basis, the US business has returned to a growth of 0.9% year-on-year, but Other Established Markets was down by 6.2% year-on-year.
• The Emerging Markets was down by 14.5% year-on-year, with growth in China offset by pandemic impacts in India and LATAM.
• Moreover, the Company witnessed an improvement in all three franchises from the second quarter of 2020.
• Smith & Nephew had delivered a substantial improvement in performance over Q2, driven by growth in the two largest markets (the US and China).
• Recently, the Company announced an acquisition and launched multiple new innovative products that will strengthen the position of Smith & Nephew. 

Financial Highlights (for the first half ended 27 June 2020 (H1 FY20), as on 29 July 2020)

(Source: Company Website) 

• The first-half performance was in line with 1 July 2020 update. The decrease in performance was driven by government-led restrictions to control Covid-19.
• The Company has launched new products, including EVOS◊ in Trauma and OR3O◊ Dual Mobility Hip System.
• Smith & Nephew witnessed a strong balance sheet and sound liquidity, with $3.4 billion of committed facilities and net debt (excluding lease liabilities) of $2.1 billion.
• The Company has maintained the investment in R&D, with a new robotics platform and other new product introductions.
• The interim dividend per share stood at 14.4 cents and was in line with 2019.

Financial Ratios

Share Price Performance Analysis

(Source: Refinitiv, chart created by Kalkine Group)

On 29 October 2020, at the time of writing (before the market close, at 11:55 AM GMT), Smith & Nephew Plc shares were trading at GBX 1,358.00, down by 1.95% against the previous day closing price. Stock 52-week High was GBX 2,023.00 and Low of GBX 1,055.01, respectively. From a technical standpoint, we could see a positive movement in the share price based on the 50-day RSI level.

Based on 2-year performance, SN. has outperformed the FTSE All-Share Health Care Equipment and Services index and FTSE-100 index. SN. generated a return of 9.5%, whereas FTSE All-Share Health Care Equipment and Services index return was -9.03% and FTSE-100 return was -20.36%

In the last five years, Smith & Nephew Plc share price has delivered 25.43% return as compared to negative 13.28% return of FTSE 100 index, which shows that the stock has outperformed the index during the last five years.

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Business Outlook Scenario

The performance of the Company has been impacted by the pandemic as the revenue growth declined in the first nine months of 2020, which was mainly due to Covid-19 mayhem. The Company has witnessed a slight recovery in Q3 2020, but it is cautious over the future, and thus it withdrew the forward-looking guidance. The new restrictions related to covid-19 are highly uncertain, and it is early to state the impact. The Company has a strategy to invest in the high growth segment, and in September 2020 it signed a deal to acquire the Extremity Orthopaedics business of Integra LifeSciences Holdings Corporation. The purchase agreement is for USD 240 million, and it would bring cost synergy and strengthen extremities business. The Company has a substantial liquidity headroom, experienced management and an established strategy, which would support the business in the medium term. The Company has a capital allocation framework that prioritizes reinvesting cash in organic growth and returns excess cash to shareholders.

Considering the decent performance in Q3 FY20, robust balance sheet position, strong cash returns, the launch of new innovative products,  and support from the valuation as done using the above method, we have given a “BUY” recommendation on Smith & Nephew at the current price of GBX 1,358.00 (as on 29 October 2020, before the market close at 11:55 AM GMT), with lower-double digit upside potential based on 29.82x Price/NTM Earnings (approx.) on FY20E earnings per share (approx.).

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

*Dividend Yield may vary as per the stock price movement.

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