Smith & Nephew in uphill battle with macro headwinds

There were no nasty surprises lurking in Smith & Nephew’s (SN.) 2022 results. But investors can't celebrate just yet. Revenue was flat – though this had largely been anticipated – and rising costs ate into profits. The medical technology group is currently striving to break a pattern of underperformance, with management introducing a 12-point plan for growth last year.

As the group progresses through the two-year life of the plan, CEO Deepak Nath said it expects “further operational and financial benefits, including a reduction in inventory levels and cash conversion to return to historic levels”. However, short-term success will largely be determined by factors outside of the company’s control. 

Trading profit margins shrunk to 17.3 per cent in 2022 – down from 18 per cent the year before. The decline was blamed on inflation in freight and logistics costs, as well as China’s volume-based procurement (VBP) scheme. The programme is designed to lower the cost of medical consumables by tendering large swathes of its medical devices market to the manufacturer that offers the lowest price.    

For the 2023 financial year, Smith & Nephew is targeting revenue growth and trading profit margins above last year’s levels. Its 2025 guidance is more bullish still – with management aiming for profit margin expansion to “at least” 20 per cent. As analysts at UBS note, this implies 125 basis points (bps) of margin expansion in each of the next two years.

“The company has only delivered 100bps or more three times since 2006 and those were years immediately post the financial crisis... or immediately post Covid,” they wrote in a 21 February note. 

Much depends on the group’s ability to turn its key orthopaedics division around. By its own admission, this part of the business has been hobbled by “poor operational systems and commercial execution”. One of the major objectives of the 12-point plan is to regain lost momentum in hip and knee implants. 

There is some evidence of progress, with Smith & Nephew reducing its number of overdue orders by 35 per cent from the peak in the first half of last year. Investors are also hoping that some new faces in senior management will help to drive the company’s transformation. CEO Nath is only a year into his tenure, and it was announced last week that former Serco (SRP) chief executive Rupert Soames will be stepping in as chairman.

Shares currently trade at roughly 15 times expected 2024 earnings, a relatively lowly rating in the medtech field. But with so much uncertainty surrounding its overhaul-in-progress, we’d say that constitutes fair value. Hold.

Last IC view: Hold, 1,078p, 28 July 2022