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Smith & Nephew's sales woe

Created:
13 May 2008
Written by:
Richard Hemming

Shares in hip replacement specialist Smith & Nephew have fallen 16 per cent since the company announced, at the start of the month, that it will lose $100m (£51m) a year in sales after uncovering “unacceptable” sales practices in Plus Orthopedics - a Swiss company purchased last year for $889m.

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Of the $100m in sales affected, about $60m were attributable to its Greek operations and the remainder were in other continental European markets - not in the UK or the US. Smith & Nephew estimates that this will hit annual earnings by $25m, with the cost this year set to be higher due to legal costs. Chief executive David Illingworth, who only took the position last year, said that he was confident Smith & Nephew would finalise its investigations quickly. His comments have angered shareholders because of the time taken to make the problem public - apparently the group had been aware of the issue since taking over Plus in June last year.

In the US, in the past six months, a number of major orthopaedic businesses have been fined by the Department of Justice over the use of sales tactics which involved the provision of excessive incentives, such as offering holidays for doctors recommending devices.

EVOLUTION SECURITIES

Reduce. In the Plus Orthopedics mis-selling episode, Smith & Nephew looks to have sustained a modest financial hit, but a rather more substantial reputational hit. The shares have probably fallen too far already on purely financial fundamental grounds, although it's debatable whether market sentiment will allow for a recovery in the short term. Still, there is the prospect that Smith & Nephew could receive something through a claim on the warranties lodged by the Plus vendors.We are forecasting EPS for 2008 of 30.1p, increasing to 34.7p the following year.

DRESDNER KLEINWORT

Buy. We have lowered our price target from 730p to 650p, although following the share price fall with the results, we have upgraded the recommendation to a 'buy' from an 'add'. Adjusting for the issues at Plus does, however, significantly lower sales growth expectations. We are expecting EPS of 32.4p for 2008, rising to 36.7p the following year. One of the positive drivers should be a stronger focus on arthroscopy within the endoscopy division, which is expected to improve the group's sales focus and drive growth.

IC VIEW

FairlyPriced

Management has suffered a credibility hit on the back of the problems at Plus. And while it's possible at least that a bidder could emerge, the shares, at 548p - and trading on about 18 times 2008's expected earnings - look no better than fairly priced.

Last IC View: Fairly priced, 570p, 2 May 2008

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