Smith & Nephew grows profits and margins

Full-year figures for Smith & Nephew (SN.) belie the group’s share price performance over the same period. The manufacturer of medical devices beat guidance on the sales front despite an unfavourable currency adjustment. It also registered a 7.6 per cent increase in adjusted operating profit – ex-restructuring, M&A, and amortisation costs – to $970mn (£764mn). The related underlying margin increased by 20 basis points to 17.5 per cent and management forecasts that it will reach at least 18 per cent in the current year.

Group chief executive Deepak Nath said that Smith & Nephew, in keeping with the beneficiaries of its specialist kit, is now on “a clear improvement path”, noting that almost half of its 2023 growth came from products launched in the past five years. That included new launches linked to robotics, shoulder arthroplasty and negative pressure wound therapy. It isn’t an industry where you can afford to sit still, but management kept a lid on R&D spending in the period under review, although the capital expenditure cash outflow increased by 19 per cent to $427mn.

The group’s operating cash flow improved markedly as inventories began to fall by its year-end, reducing the working capital burden. Consequently, the trading profit to cash conversion ratio improved by 16 percentage points to 65 per cent. Financial performance may be constrained by ongoing inflationary pressures and volume issues linked to the Chinese market, although these stumbling blocks are expected to be “more than offset” by positive operating leverage and benefits accruing from the group’s remedial 12-point plan, announced in July 2022.

One of the primary objectives of the plan centres on improving operational and financial performance within the orthopaedics business. Progress is already evident in the growing percentage of customer order lines filled and improved inventory management. Specific measures relating to enhanced sales training and improved incentives have been taken to address the performance of the unit engaged in hip and knee implants in the US, which “remains a priority”. Other measures have been taken to improve performance within the group’s advanced wound management and sports medicine & ENT business units.

The market reacted favourably to these figures, unsurprising given broad-based growth across all business units and geographies. The group, while not exactly in turnaround mode, is taking practical measures that are supportive of margins, and growth should benefit from the roll-out of specialist applications, most notably the CORI Surgical System. It’s a work in progress, but the forward rating of 16 times doesn’t appear daunting when set against industry peers. Buy.

Last IC view: Buy, 924p, 26 Oct 2023