Monday, June 27, 2011

SN.L - Smith & Nephew - company profile

Overview of activities
SN. (Smith & Nephew) trades in the medical equipment sector. It operates in three areas:
  • orthopaedics - hip, knee and shoulder joint replacements, as well as ancilliary products like nails for hip fractures (ouch!) and bone cement. The company also offers clinical therapies like an ultrasound bone healing system.
  • endoscopy - SN. makes devices for minium intervention (think keyhole surgery), concentrating on sports medicine, particularly the knee, shoulder and hip joints. Devices include digital camera, scopes, light sources, monitors and blades.
  • advanced wound management - a range of products from initial wound bed preparation through to full wound closure. These products are targeted at chronic wounds (i.e. wounds that take a long time to heal, over three months, years, or if at all) associated with geriatrics, such as pressure sores and leg ulcers; although it does have products applicable to all ages, like wounds caused from burns or invasive surgery. Such products includes dressings, gels, draining tubes, vacuum-assisted pressure devices to promote healing.

Market and competition

  • Orthopaedics. Orthopaedics isn't just for geriatrics; it encompasses younger people with sports injuries and accidents. SN. sees emerging markets, particularly China, as an important area for growth. SN. holds about 11% of global market share. Orthopaedics is not immune to wider economic woes, as weak conditions tend to promote deferrals in surgery and heightened pricing pressures. Over the longer term, SN. expects sustainable growth due to ageing populations, increasing obesity and diabetes, technological improvements allowing younger patients to be treated, and increasing demand from emerging markets.
  • Endoscopy. SN intends to grow this business, and capitalise on the increasing acceptance of endoscopy  as a preferred surgical choice. Emerging markets are expected to be a major driver of growth; again, particularly in China. Management estimates that the market has recently been growing between 8% and 12% annually., driven by increasing number of sports injuries, patient desire for less invasive surgical procedures, and their cost-effectiveness.
  • Advanced Wound Management. SN. intends to focus on high growth, high value segments, particularly exudate and infection management. Exudates are fluids that filter from the circulatory system to lesions or areas of inflammation. So, for instance, if you cut your finger, blood flows out and forms a clot around it. That's an exudate. Growth has been about 4% during 2010, and SN. has about 18% of the market. Growth is driven by an ageing population, technology advances, and improvements in cost-effectiveness.

Orthopaedics and endoscopy tend to exhibit some seasonality, but wound management shows very little.

SN. have customers in over 90 countries worldwide. Competition exists among healthcare providers to gain patients on the basis of quality, service and price. Providers are under pressure to reduce the total cost of healthcare delivery.


At a share price of 636p, SN. has a PE of 13.8, EV/EBITDA of 7.4, market cap of £5.7bn, and a yield of 1.6%, covered 4.6 times.

SN. spends about 4% of revenues on R&D. It spent $151m in 2010, $155m in 2009, and $152m in 2008. In 2010, SN employed 10,172 people.

SN. has grown its EPS at about 13% pa over the last decade; an impressive figure. Analyst forecast EPS growth of 4% in 2011, and a further 10% in 2012. EPS has shown a record of increasing earnings for all years except 2006, when there was a dip of 10% as measured in Sterling terms. The company usually reports in USD, and on this basis, has had an unbroken record of increasing earnings during that period.

The balance sheet is in excellent health. It has net debt of £303m, positive net current assets, and non-current liabilities of £650m. Against net profits for the year of £380m, those non-current liabilites could be repaid in 1.7 years; a very comfortable ratio, especially given the consistency in earnings. It has a z-score of 5.4, a very high rating, and a gearing of 18% (39% on a tangible basis).

During the last 5 accounting periods, the company reported total operating profits of £2023m, and total depreciation charges of £774m; giving a combined total of £2797m. Its operating cash flows for the period totalled £2499m, about 90% of this figure. So, earnings quality could be better, but I do not see any undue cause for concern.

Median ROE for the last decade was 27%, achieved with little  debt. ROCE figures have been high, too. This suggests that the company enjoys superior economics.


SN. operates in a competitive but lucrative environment. It enjoys high returns on capital, retains much of its earnings, and has a solid balance sheet from which it can innovate further and grow earnings. Earnings grow consistently. In short, it is a high quality company with good long-term growth potential. In terms of valuation, a PE of less than 14 is acceptable for this type of company. Valued in terms of EV/EBITDA, it is much cheaper than the market (which is around 10), thanks due to the strength of the balance sheet. SN. therefore passes in terms of Quality, Growth and Value. Although analyst forecasts look unexciting in the near term, the company looks solid from a long-term perspective. As of the day of writing, SN. announced the acquisition of Tenet Medical Engineering; demonstraing that SN. can grow both organically and by acquisition.

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