Smith & Nephew PLC (LON: SN.) – Focus on launching new products, maintain robust balance sheet, and invest in R&D activities

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 US$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 13th August 1951. On 18 February 2021, the Company will announce the Q4 FY20 and 2020 full-year results.

(Source: Presentation, Company Website)

Growth Prospects and Risk Assessment

The agreement to acquire Extremity Orthopaedics business of Integra Life Sciences Holdings Corporation for $240 million, will expand the portfolio in higher-growth extremities segment. Moreover, the successful debut of US$1 billion US bond issue shall provide attractive long-term funding to invest in delivering the Group's strategic imperatives. In FY20, the Group has launched multiple new innovative products and announced an acquisition that will strengthen the business position. In China, the Company has received approval from the National Medical Products Administration to introduce its REDAPT System for total hip arthroplasty. Furthermore, the Company has maintained the investment in R&D, with a new robotics platform and other new product introductions.

However, the business is exposed to several principal risk factors, such as cybersecurity, regulatory changes, failure to launch new products, talent management, pricing and reimbursement, commercial risk, unsuccessful integration of acquired businesses, political and economic factors. Besides this, emerging risk of Covid-19 has been affecting the business continuity and causing a substantial amount of financial risk. 

Industry Outlook Dynamics

The Global medical device market is expected to reach over US$612 billion by 2025 from around US$424 billion in 2018, accelerating at a CAGR of 5.4 per cent (as per the 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 US$300 billion in annual sales by 2030. Moreover, China and India markets have the potential to reach over US$200 million and US$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, geopolitical factors, and competition.

A Glimpse of Business Segments (H1 FY20)

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

• 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.
• The Company saw a significant recovery from the previous quarter (Q2 FY20), with Q3 revenue of $1,200 million.
• Recently, the Company announced an acquisition and launched multiple new innovative products that will strengthen the position of Smith & Nephew.
• Smith & Nephew delivered a substantial improvement in performance over Q2, driven by growth in the two largest markets (the US and China). While it is well prepared as global levels of elective surgery recovered.
• In Q3 FY20, the Company launched “The Core of Real Intelligence” (CORI) surgical system for unicompartmental and total knee arthroplasty.

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

(Source: Company Website)

• The Company has launched new products, including EVOS◊ in Trauma and OR3O◊ Dual Mobility Hip System.
• 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 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.
• SN has a substantial liquidity headroom, experienced management and an established strategy, which would support the business in the medium term.
• 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. 

Financial Ratios (H1 FY2020)

Share Price Performance

On 17 December 2020 (before the market close, at 8.50 AM GMT), SN.’s shares were trading at GBX 1,522.00, up by 0.03% against the previous day closing price. Stock 52-week High and Low were 2,023.00 and GBX 1,055.01, respectively.

From the technical standpoint, 14-day RSI (55.82), 50-day SMA (1,474.20), and 50-day EMA (1,490.50) are currently supporting an upside potential, which means the stock price could increase in the short term. Also, the MACD line is placed above the central line, indicating a bullish setup. The Company’s stock has delivered a positive return of around 32% in the last nine months.

In the past five years, SN.’s share price has delivered ~40.10% return as compared to the ~8.41% return of FTSE 100 index, and a negative ~0.97% return of FTSE All Share Health Care Equipment & Services index, which shows that the stock has outperformed the benchmark index and the sector.

Valuation Methodology: EV/Sales Approach (NTM) (Illustrative)

Business Outlook Scenario

The full-year guidance remained withdrawn as nature and scope of new restrictions to control Covid-19 through year-end are not known. However, the Group is encouraged by the improved performance delivered in the Q3 FY20 and have the system in place to rapidly respond to the changes impacting the business. Looking to the medium-term, it has a proven strategy, robust balance sheet and strong management team. It remained committed to consistently outgrow the market and delivering ongoing improvement to its trading profit margin. The Company has shown encouraging signs of activity rebuilding in the core markets and it will also take advantage when markets recover. Further, the Company’s current ratio is higher than the industry, which shows SN has enough cash to recover the short-term obligations. 

(Source: Presentation, Company Website) 

Considering the decent performance in H1 FY20 and in Q3 FY20, robust balance sheet, strong cash returns, launched multiple new innovative products, continuously increased the research & development investment, healthy performance over the last five years, 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 1,522.00 (as on 17 December 2020, before the market close at 8:50 AM GMT), with lower-double digit upside potential based on 4.97x EV/NTM Sales (approx.) on FY20E sales (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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