An ageing population and a hip and knee replacement company ought to be a match made in heaven. So why have Smith & Nephew (S&N) investors had such a hellish time?
The shares are down 38 per cent over the past five years and nearly 6 per cent since the beginning of 2024.
There are myriad reasons for this. These range from a well-publicised (but now resolved) revolt over new chief executive Deepak Nath’s whopping £9.5 million pay packet to fears that the popularity of weight-loss drugs, such as Ozempic, may mean fewer of us rely on knee replacements.
What investors need to decide is whether pessimism over S&N’s future has been overdone and if Nath’s much-vaunted 12-point-plan will deliver a recovery that will produce a meaningful uplift in the shares.
First, let’s look at what went wrong. S&N has three main divisions: orthopaedics, sports medicine and advanced wound management. Before Covid, the company had operating margins of more than 20 per cent, but this collapsed after the pandemic with the company struggling with supply chains and inflation, particularly in orthopaedics.
Hellish time: An ageing population and a hip and knee replacement company ought to be a match made in heaven
Nath joined in April 2022 and rolled out a new plan to fix the orthopaedics division with improved inventory management and training, while growing the other two divisions.
The first quarter trading update last week showed that much of this plan is on track. Orthopaedics is growing outside the US, while sports medicine and advanced wound management are performing to expectations.
On the other hand, the company is suffering from China’s new Volume Based Procurement strategy, which forces huge price reductions on to manufacturers. This is affecting its sports medicine division while struggles remain with its market share in the US for hips and knees. Analysts broadly welcomed the figures, even though they slightly missed some forecasts for the first quarter.
Seb Jantet, healthcare analyst at Liberum, says the US is still battling with supply issues for hips and knees, but there is potential for upside if the business resolves this.
He adds that Volume Based Procurement will drag down revenues for sports medicine and joint repair by 5 per cent.
Jantet predicts 5 per cent underlying growth for the full year and believes the company is undervalued.
‘The shares haven’t performed well since February and it isn’t entirely clear why,’ he says.
Julien Dormois, at broker Jeffries, agrees that the current weak share price is an opportunity.
‘Smith & Nephew is reaping the benefits from portfolio shifting toward faster-growth segments and recent R&D efforts, which support higher, sustainable growth,’ he says.
‘We think the lacklustre stock performance allows investors to revisit the case.’
There are headwinds, though, including the issues in China and the possibility that the company may not hit its ambitious targets.
But these should not detract from the fact that the shares are attractively priced.
S&N is paying a 3 per cent dividend and is trading on around 12 times the forecast earnings for 2025 – that means that the shares are priced at 12 times the profits that the company is expected to make next year. This is its lowest forward earnings rating for more than ten years.
Nearest London-listed rival Convatec trades on 18 times earnings so is much more expensive.
There may yet be more disquiet over Nath’s remuneration, which he will only receive in full if he hits his targets, but this is a company still actively innovating in robotic surgery and wound care.
Midas verdict: Appropriately for a business that started off refining cod liver oil, the stock market seems to be finding Smith & Nephew’s recovery plans a bit fishy.
Scarred by recent upsets and concerned by the slow resolution of US supply chain issues, it takes very little to knock confidence – and, therefore, the share price.
There is value to be had for brave investors, however. The business works in sectors that are ever more necessary, and its innovations show the company is still progressive.
S&N is far from perfect – but, overlooking the issues, the company is cheap and worth buying for short-term upside.
Traded on: London Stock Exchange Ticker: SN Contact: smith-nephew.com or 0370 703 0047
