What are the long-term prospects for Smith & Nephew (LON: SN.)?
I'm always searching for shares that can help ordinary investors like you make money from the stock market.
Right now I am trawling through the FTSE 100 (UKX) and giving my verdict on every member of the blue-chip index.
I hope to pinpoint the very best buying opportunities in today's uncertain market, as well as highlight those shares I feel you should hold… and those I feel you should sell!
I'm assessing every share on five different measures. Here's what I'm looking for in each company:
1. Financial strength: low levels of debt and other liabilities;
2. Profitability: consistent earnings and high profit margins;
3. Management: competent executives creating shareholder value;
4. Long-term prospects: a solid competitive position and respectable growth prospects, and;
5. Valuation: an under-rated share price.
A look at Smith & Nephew
Today I'm evaluating Smith and Nephew (LSE: SN) (NYSE: SNN.US), a global medical devices company specialising in orthopaedic reconstruction and trauma, endoscopy, and advanced wound management, which currently trades at 684p. Here are my thoughts:
1. Financial strength: The company is in solid financial health, with a reported net cash position of $379m as of the recent quarter results and an interest cover of a hefty 121 times.
2. Profitability: Over the past 10 years, Smith & Nephew has had consistent long-term growth compounding revenues by 10% per year, adjusted-earnings per share by 13% per year, and dividends per share by 10% per year, while keeping operating margins consistently above 18%, and achieving high returns-on-equity (ROE), averaging 24%.
3. Management: Olivier Bohuon took over as CEO following the retirement of David Illingworth in April 2011. Although he has no previous experience in the medical devices industry, he has worked in the pharmaceutical industry for two decades. Just a few months after taking over, he has already initiated several moves, which included restructuring the former orthopaedic and endoscopy segments under one division, a cost-efficiency programme that will save $150m a year, increasing R&D spending as well as new strategic efforts focused on emerging market growth.
4. Long-term prospects: Smith & Nephew’s operates principally in two business segments: advanced surgical devices, composed of the former orthopaedic and endoscopy units, and advanced wound management.
The orthopaedic segment, which brings in more than half of the group‘s revenues, has been experiencing declining margins and revenues lately, with the global orthopaedic market growing only by 2% in 2011, mainly due to a weak economic climate and increasing regulatory pressures. In this business, Smith & Nephew holds an 11% market share, trailing Zimmer, 19%, Stryker, 18%, and Johnson and Johnson, 17%. However, the group sees sustainable long-term growth in this area, driven by a growing and ageing population, rising rates of diabetes and obesity worldwide, improvements in technology to treat younger patients, and the increasing demand for healthcare in emerging markets.
In endoscopy and wound management, the group is one of the market leaders, holding a market share of 21% and 18%, respectively. The global endoscopy market has been enjoying robust growth recently, increasing by 8% per year, driven by increasing patient demand for minimally invasive and cost-effective procedures. While the advanced wound management segment has been the best performing segment since 2011, increasing by 12% and continues its strong performance through the recent quarter, growing by 4%, doubling the market rate. Management believes that the market is still largely unpenetrated and offers huge potential for growth.
5. Valuation: Smith & Nephew’s shares are currently trading at a projected price-to-earnings (P/E) ratio of 14 for the year, which is at the lower range of its historical P/E ratios. However, its expected dividend yield of 2.5% is relatively weak compared to the FTSE 100 average of 3.4%.
My verdict on Smith & Nephew
Despite its poor results lately, Smith & Nephew remains an excellent business with a strong competitive advantage, as shown by almost 10 years of increasing revenues, dividends and earnings; consistently high margins; and excellent returns on equity. Slowing growth in its established markets is offset by efficiency gains, emerging market growth and favourable demographic and lifestyle trends.
So, overall, I believe Smith & Nephew at 684p looks like a buy.
More FTSE opportunities
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In the meantime, please stay tuned for my next verdict on a FTSE 100 share.
> Zarr does not own any shares mentioned in this article. The Motley Fool owns shares in Smith & Nephew.
