Trying to make sense of the prospects for artificial joints and medical devices maker Smith & Nephew is tricky, as the company is something of a paradox. On the one hand, its shares enjoy FTSE 100 status and it has the sort of defensive profile that pension funds love. On the other, its markets are dominated by giant US companies and it seems unable to match either their scale or profits. That's partly why Smith & Nephew is perennially seen as a takeover target and, as a result, its shares have become a play-thing of traders. So a recent spike in the price, following first-half results for 2012 when the dividend was substantially hiked, opens another opportunity to short-sell the shares.
- Dividend boosted
- Sound finances
- Sedate growth of medical devices markets
- Time needed to build emerging markets presence
- Dubious record on acquisitions
- Prospects linked to mature economies
The problem with the shares' re-rating is that Smith & Nephew's underlying market, while overtly stable, is essentially weak. The second quarter saw some of the major companies report improvements in the US, particularly for prices, but these were more than offset by austerity pressure in Europe, which is set to worsen as the continent drifts back into recession. Analysts at broker Investec Securities attribute most of the improvement to orthopaedic companies benefiting from changes in sales mix and growing their market share, with underlying demand showing few signs of improvement. The global market for medical devices grew by about 2 per cent, which Smith & Nephew matched.
Meanwhile, investors hope that the major medical devices companies can latch onto the potential in emerging markets. Smith & Nephew has made growth in so-called Bric (Brazil, Russia, India, China) countries a priority, with the intention of acquiring a foothold beyond its base in China. The trouble is that the 'emerging markets story' is old hat. It is taken for granted that companies prepared to invest in them and bring products to market will see the benefit as fast-growing countries become prosperous. But the problem with this argument is the same one that confronts Smith & Nephew everywhere - how to achieve meaningful growth against powerful competitors?
SMITH & NEPHEW | ||||
|---|---|---|---|---|
| ORD PRICE: | 666p | MARKET VALUE: | £5.98bn | |
| TOUCH: | 666-667p | 12-MONTH HIGH: | 687p | LOW: 515p |
| DIVIDEND YIELD: | 2.6% | PE RATIO: | 13 | |
| NET ASSET VALUE: | 252p | NET CASH: | $150m | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2009 | 3.77 | 670 | 53.4 | 14.4 |
| 2010 | 3.96 | 895 | 69.3 | 15.8 |
| 2011 | 4.27 | 848 | 65.3 | 17.4 |
| 2012* | 4.14 | 1,093 | 82.0 | 26.1 |
| 2013* | 4.17 | 902 | 69.2 | 26.7 |
| % change | +1 | -17 | -16 | +2 |
Normal market size: 4,000 Matched bargain trading Beta: 0.9 *Investec Securities forecasts £1=$1.75 | ||||
The company aims to quadruple its revenues from emerging markets to $500m (£320m) by 2016 by allocating 20 per cent of its projected $450m research and development spending over that period specifically to Bric markets. Acquisitions may add to that amount. This investment is understandable in the current climate of slow growth in the developed world, but the progress may be painfully slow, as portfolios of products, manufacturing sites and sales teams need to be organised and drawn together before making a dent in competitors' sales.
Acquisitions will play a part in this process - management has indicated as much - but that may be a curse, given Smith & Nephew's poor track record of buying companies. For example, it only recently settled bribery charges in the US, on payment of a $17m fine, after a company it bought in Greece turned out to be riddled with fraudulent practices. Buying companies in China, Russia or Brazil may be fraught with even greater difficulties, so investors should be wary of Smith & Nephew's ability to deliver on its acquisitions until success if clearly proven.
For the time being, medical devices companies will continue to make the bulk of their profit in Europe and the US and, if these economies aren't growing much, they won't either. In other words, the share price rise recently seems a case of overpaying for the potential of a plan rather than the likelihood of what will transpire.
On the positive side, investors saw the dividend hiked at the last results, as the group's bosses believed they could pay out more of retained profits. That said, the yield is still nothing to get excited about (see table). The balance sheet looks healthy, with City analysts forecasting that management has about $2bn of headroom for acquisitions, if there is anything of sufficient scale worth buying.
