After a fairly healthy first year on the stock market, shares in the £3.7bn cap medical product and technology company plunged mid-October following news that the business was losing orders after experiencing severe supply problems in its wounds and ostomy care divisions.
This setback, combined with a “lower than anticipated revenue contribution from new products” led the company to slash its organic revenue growth forecast for the full year to between 1% and 2% from the 4% it predicted back in May.
Although the aforementioned supply problems in both divisions are expected to be mostly resolved by the end of Q4, it’s understandable that many investors have continued to head for the exits over the last few weeks. The shares now stand at 190p — a full 45% lower than the price they changed hands for back in June. Not even a recent upgrade from analysts at UBS — combined with their belief that the stock is pricing in an “overly bearish scenario” — has lifted sentiment.
But it’s not just recent issues that make me want to avoid the stock for now. Although demand for its products is likely to rise as life expectancy grows, ConvaTec is still saddled with a huge amount of debt on its balance sheet. Returns on the money invested by the company have also been very average.
Then there’s the valuation to consider. Despite the recent bad news, ConvaTec’s price-to-earnings ratio (P/E) of 15 for the current year still feels too rich for a company highly likely to be demoted from the market’s top tier in the next reshuffle. A rather uninspiring forecast 2.3% yield also feels like a scant reward for those investors willing to wait for a recovery.
Those drawn to the market in which ConvaTec operates but unwilling to risk buying its shares may find peer, Smith & Nephew (LSE: SN) a more palatable option.
Over the last five years, shares in the £12bn cap medical device business have more than doubled in value — a decent return for such a large company. While unlikely to repeat this performance over the next five years, I think the stock still warrants consideration following last week’s Q3 trading update.
Trading on 20 times forward earnings, Smith & Nephew’s stock certainly isn’t cheap. Nevertheless, the high operating margins and returns on capital generated by the company suggest this valuation can still be justified. While not boasting a net cash position, Smith and Nephew also carries far less of a debt burden than ConvaTec.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.