Smith & Nephew plc (SN.) Ordinary USD0.20

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Smith & Nephew’s underlying revenue grew 4.0% to $1.4bn in the third quarter. Growth in all three of its business units (Orthopaedics, Sports Medicine & ENT, and Advanced Wound Management) were below market expectations. This comes as volume purchasing pressures from China continue to weigh on performance.

As a result, full-year underlying revenue guidance has been lowered to 4.5% growth (previously 5-6%).

Full-year trading profit margin (underlying EBITA) guidance has also been lowered from at least 18%, to between 17.5-18% driven by slower revenue growth. The 2025 trading profit margin target has also been cut to 19-20%, down from around 20% previously.

The shares fell 13.9% in early trading.

Our view

Smith & Nephew’s third-quarter numbers made for some tough reading for investors. Revenue growth missed market expectations across all three divisions, dragging down the group’s full-year targets with it.

The shortfall largely stems from a change in the way China buys its medical devices. Its bulk-buying approach drives down the prices Smith & Nephew can charge. That ultimately puts downward pressure on revenue, which has knock-on effects on profitability too. As a result, both this and next year’s profit targets took a hit as other regions weren’t able to fully pick up the slack.

The medical device maker operates through three segments; Orthopaedics - offering hip and knee replacements, Sports Medicine - a soft tissue repair business, and Wound Management - providing materials to manage injuries and prevent infection.

The Orthopaedics division has been a problem child for the group, hampered by a lack of scale. Operational improvements have had some success in overseas markets and there’s hope that can be replicated in the US.

An ageing population and growing affluence in emerging markets are both tailwinds for surgical procedure growth. But Smith & Nephew is not just sitting and waiting for the market to drive its sales growth. It's continuing to develop, acquire, and launch new products, cross-sell its wide product range across its territories, and introduce existing products into new areas of treatment.

We see innovation as its biggest weapon for targeting higher market share. The group’s negative pressure wound therapy products continue to evolve as management targets a multi-year growth opportunity. Its regenerative therapies for sports injuries are also seeing strong sales momentum.

But while there are some structural growth opportunities, the group does face some challenges.

Rebuilding margins is proving harder than expected, largely due to the issues with China. Underlying operating margin targets have been pushed further down the road again and are materially behind the original recovery plan.

Market forecasts suggest a prospective yield of 2.9%, but as ever there can be no guarantees. And given the relatively high debt levels and drive for product innovation, there may be limited scope to increase payouts to shareholders.

These continued disappointments are reflected in the valuation which sits some way below the long-term average. Investors could be rewarded if Smith & Nephew steps up its game and makes good on its promises. But the market will need to see a string of evidence that productivity is improving before getting too excited, and further setbacks can’t be ruled out.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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