Shares per ADS: 5:1
Note: This report contains substantially new information. Subsequent reports will have changes highlighted.
Reason for Report: 1Q13Earnings
Prev. Ed.: Mar 25, 2013; 4Q12 and FY12 Earnings (broker materials considered till Feb 21)
Brokers’ Recommendations: Neutral: 66.7% (6 firms); Positive: 22.2% (2); Negative: 11.1% (1) Prev. Ed.:6;2;1
Brokers’ Target Price: $56.67 (↑ $0.21 from the previous report, 4 firms) Brokers’ Avg. Expected Return:-4.0%
*Note: Though dated Jun 26, 2013, share price and broker material as of May 14.
*A Flash Update was provided on May 3, 2013.
*We did not have access to the firm with negative rating.
Note:The tables below (Revenue, Margins, and Earnings per Share) contain material from fewer brokers than in theValuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
Smith & Nephew (SNN) is a major international medical devices business, operating in the markets for orthopedic reconstruction and trauma, endoscopy and advanced wound management.
Out of 9 firms covering the stock, 6 (66.7%) assigned neutral ratings, 2 (22.2%) conferred positive rating while 1 (11.1%) provided a negative rating to the stock.
Neutral or equivalent outlook (6/9 firms):These firms view FY13 as an inflection point in the company’s operating history. As a result, they refrain from suggesting the stock unless they see any significant improvement in market conditions.According to these firms, macro economic problems in Europe, softness in the knee market, aggressive competition from larger companies with deeper pockets and lack of growth drivers might adversely impact Smith & Nephew’s performance. Moreover, they expect these headwinds to persist in the medium-term. According to them, the situation in Europe will continue to remain unfavorable with some countries increasingly adopting austerity measures. Their concern is reflected by the softness in the German market. According to these firms, pricing pressure in the region is another downside. Moreover, despite 88% revenues coming from Established markets, only Japan is witnessing healthy growth. While these firms are encouraged by the higher growth in certain divisions (such as woundcare), they are wary that this might not be enough to offset the dragging sales of knee and hip franchise. Further, these firms envisage FY13 Advanced Surgical Devices (ASD) sales growth to slowdown from current levels as reflected in the estimated growth rate for the various units. Despite the acquisition of Healthpoint Biotherapeutics, these firms are cautious as Smith & Nephew has failed to substantially benefit from such deals in the past. The firms are cautious as the company’s increasing focus in the emerging markets will not only expose it to currency headwinds but might also hurt margins. These neutral firms prefer to remain on the sidelines until these headwinds wane.
Positive or equivalent outlook (2/9 firms):These firms remain upbeat on Smith & Nephew, owing to its better-than-expected 1Q13 results. These firms adopted a bullish stance primarily banking on higher profitability throughout FY12 which according to them is likely to continue in FY13. They also expect accretion from the recent acquisition of Healthpoint Biotherapeutics. The bullish firms expect the Healthpoint deal to beef up Smith & Nephew’s fast growing Advanced Wound Management (AWM) division. After consideration of the latent growth opportunities in the AWM market, theyexpect the company to significantly benefit from the deal. Moreover, the firms expect Smith & Nephew to boost shareholder returns via share repurchases and dividend hike, given the company’s solid cash position. They also expect such capital deployment activities to bolster the company’s bottom-line. These firmsare also bullish regarding the company’s diversified revenue base (apart from orthopedics and reconstructive). They are positive about arthroscopy and endoscopy business doing well in the upcoming quarters. Although these firms expect Smith & Nephew to witness a light 1H13, they are optimistic about growth acceleration in 2H13 and FY14. These firms believe that emerging nations present a lucrative growth opportunity for the company. They believe that demographic trends in the end market coupled with increased insurance coverage will further drive revenue. Additionally, the firms assert that the U.S. market remains largely unsaturated. The firmsare also positive regarding the company’s pipeline development. Smith & Nephew is also on track to generate costs saving of $150 million through FY14. Finally, they believe that Smith & Nephew has considerable resources to fuel growth.
Jun 25, 2013
Overview
Based in London UK, Smith & Nephew Plc (SNN) is engaged in the development, manufacture, and marketing of medical devices worldwide. This strategy has five priorities – focus in established markets, growth in emerging markets, innovation, simplification of operating model and supplementing organic growth through acquisitions. The company’s new framework consists of two divisions – Advanced Surgical Devices global (ASD with Orthopedics and Endoscopy under one management) and Advanced Wound Managementglobal. These two divisions will serve the U.S. and other Established markets and also support the newly created Emerging Markets and International Market Organizations. For more information on the company, please visit its website
The company is benefiting from its new strategic framework. In FY12, Smith & Nephew’s strategic priorities yielded positive results. According to management, the company is on a path to generate $150 million efficiency savings by the end of FY14.The progress follows the reorganization and realignment of the segments, strategic measures to reduce costs and refine manufacturing footprint among others.
On Dec 21, 2012, Smith & Nephew acquired Texas-based Healthpoint Biotherapeutics for $782 million in cash. For the past few years, Healthpoint has been working successfully in acute, chronic, and burn-related wound care management and is currently a big name among the biopharmaceutical companies. The company’s Collagenase Santyl ointment is an important contributor to growth in the commercial platform. Besides, the company developed an advanced cell therapy, HP802-247, which has successfully completed the phase 2b study in 2011. In Sep 2012, the North American phase 3 trial for the same was initiated.
Smith & Nephew considers this acquisition as an important step toward creating a strong portfolio in bioactives, the fastest growing area of advanced wound management.According to the company, this will be effected through material revenues from a fast growing product range, an attractive pipeline and the commercial and R&D capabilities of Healthpoint, thereby providing Smith & Nephew with new growth opportunities for the next decade and beyond.
In Jan 2012, Smith & Nephew announced an agreement with Essex Woodlands, a venture capital firm, to develop Clinical Therapies and its Biologics business further, creating a new entity called Bioventus LLC. Accordingly the company transferred the vast majority of its U.S. Biologics team and Clinical Therapies business to Bioventus LLC in return for a 49% shareholding, approximately $98 million cash and a $160 million 5-year note.Accordingly, Bioventus, comprising of Clinical Therapies and Biologics business was formed in May 2012.
The firms identified the following important factors for evaluating SNN as an investment:
Key Positive Arguments / Key Negative Arguments- The company is a prominentplayer in the medical devices space with leadership position in several of its businesses.
- Launch of new products over the recent past have benefited the company’s top line and the trend might continue in FY13.
- Successful execution of the company's cost saving initiatives is expected to boost margins.
- Capital deployment activities should boost investor confidence.
- It faces tough competition from bigger companies like Zimmer (ZMH), Stryker (SYK), and Johnson & Johnson (J&J).
- Austerity measures in Europe are a matter of concern for the company.
- The firms are cautious about higher sales from woundcare offsetting the significant drop in sales in core markets.
- Failure to synergize the Healthpoint acquisition might drag the company’s performance in the future.
Note: Smith & Nephew’s fiscal references coincide with the calendar year.
Jun 25, 2013
Long-Term Growth
Smith & Nephew’s growth depends, to a large extent, on the growth rates in the Orthopedic segment, which yields the highest margins. The firms are impressed with the well-diversified nature of the company. The businesses comprising non-reconstruction orthopedic, Endoscopy and AWM are all growing at faster rates. The company is also well diversified geographically.
Furthermore, the company follows an effective strategy of investing a significant amount in research and development to bring new products to the market. This strategy has yielded results in the past and will contribute to growth going forward. The company has invested substantial resources on the Verilast knee, a promising product. Management is also taking steps to improve operating efficiencies which could lead to long-term margin stabilization and even margin improvement. The firms are also impressed with the company’s recent strategic initiatives to ensure manufacturing efficiency and costs saving, which will thereby prepare it for long-term growth.
Having witnessed flattening growth in the matured markets, Smith & Nephew has decided to focus on the emerging markets. The firms are impressed with this decision and consider it as a positive step for the long-term growth of the company. They also believe that based on the new structure, the company will be able to focus on markets which are less mature and offer immense potential.
The firms unanimously believe that the recent acquisition of Healthpoint Biotherapeutics should enhance the company’s woundcare portfolio leading to significant incremental revenue. Moreover, management is still on the lookout for suitable acquisitions to strengthen its product portfolio.
Jun 25, 2013
Target Price/Valuation
Rating DistributionPositive / 22.2%
Neutral / 66.7%
Negative / 11.1%
Avg. Target Price / $56.67↑
Maximum Target / $60.00↑
Minimum Target / $54.00
No. of Analysts with Target price/Total / 4/9
Downside from Current / 4.0%
Maximum Upside from Current / 2.6%
Minimum Downside from Current / 7.7%
Risks to the target price include greater-than-expected pressure on volumes or pricing and failure to execute on several restructuring programs.
Recent Events
On May 3, 2013, Smith & Nephew reported its 1Q13results. Highlights are as follows:
Smith & Nephew reported EPS of $0.157 or EPADS of $0.79 in 1Q13 compared with EPS of $0.177 or EPADS of $0.89 in 1Q12. However, after adjusting for one-time expenses, the company recorded adjusted EPS of $0.185 or EPADS of $0.93 in 1Q13, which missed 1Q12 EPADS by $0.97.
Revenues were $1,075 million in 1Q13, up 1% y/y (underlying, after considering currency translation, inclusion of Healthpoint growth and exclusion of Bioventus transaction).
Revenue
Smith & Nephew reported revenue of $1,075million in 1Q13, up 1% y/y on an underlying basis (after considering currency translation inclusion of Healthpoint growth and exclusion of Bioventus transaction)butdown 1% y/y after excluding the impact of the Healthpoint acquisition. Two lesser sales-days in 1Q13 led to revenue decline of approximately 3%.
The Zacks Digest average total revenue in 1Q13was at par with the company’s report.
Among regions, revenues from the U.S. were $460million, up 4% y/y. The Healthpoint acquisition led the growth in the U.S. market. Other Established Markets which include Canada, Europe, Japan, Australia and New Zealand recorded 5% dropto $485 million.The macroeconomic environment in Europe continued to drag the company’s performance in the region. The Emerging and International markets recorded an underlying growth of 19% to $130million led by robust sales in the Chinese and Middle-Eastern market.
Provided below is a summary of revenue as compiled by the Zacks Digest:
($ in million) / 1Q12A / 2012A / 1Q13A / 2Q13E / 3Q13E / 4Q13E / 2013E / 2014E / 2015ETotal Revenue / $1,079.0 / $4,137.0 / $1,075.0 / $1,082.0 / $1,022.5 / $1,158.0 / $4,338.0 / $4,524.0 / $4,834.0
Digest High / $1,079.0 / $4,137.0 / $1,075.0 / $1,089.0 / $1,032.0 / $1,171.0 / $4,367.0 / $4,574.0 / $4,834.0
Digest Low / $1,079.0 / $4,137.0 / $1,075.0 / $1,075.0 / $1,013.0 / $1,145.0 / $4,309.0 / $4,474.0 / $4,834.0
Y/Y Growth / 2.3% / -3.1% / -0.4% / 5.2% / 7.4% / 7.5% / 4.9% / 4.3% / 6.9%
Advanced Surgical Devices (ASD) global
The ASD segment encompasses the following product franchises:
Knee Implants
Hip Implants
Sports Medicine Joint Repair
Arthroscopic Enabling Technologies
Trauma
This segment generated revenues of $760 million in 1Q13, down2% y/y on an underlying basis. This was mainly due to fewer selling days. While revenues in the U.S. decreased2% y/y, performance in Other Established markets declined 7% y/y. Economic uncertainties in Europe took its toll on the company’s performance in established markets. Maintaining the momentum, the company recorded 16% growth in the Emerging and International markets. Also, pricing pressure for the ASD segment remained unchanged in 1Q13.
The Knee Implant franchise recorded a global 6% y/y drop in 1Q13 revenue(to $219 million) versus market erosion of 1%. The European market, where the company’s revenue base is larger compared with the U.S. market witnessed considerable softness. While revenue from the business declined 5% in the U.S., it decreased 8% outside-U.S. Meanwhile, the company continued to focus on its Journey II BCS Knee System that was launched in Mar 2013.
Revenue from global Hip Implant franchise ($167 million) was down 6%y/y (down 3% excluding the Birmingham Hip Resurfacing System or BHR) against market erosion of 1%. As per management, this was mainly due to a strong comparable 1Q12.Revenue decline was attributed to persistent weakness in the metal and metal hips in 1Q13. While the sales dropped 8% in the U.S. market, it witnessed 4% decline outside U.S.
Smith & Nephew continues to battle headwinds such as timing of the product cycle against other players, sluggish European market and softness in the company’s largest market in Europe — Germany, besides ongoing softness for metal-on-metal franchise for its orthopaedic reconstruction business. The company witnessed about 10% market erosion in German recon market.
The company recorded 4% growth in Sports Medicine Joint Repair(to $120 million) in 1Q13.Revenue increased on the back of continued volume growth. The Arthroscopic Enabling Technologies franchise recorded 7% downfall in revenues (to $110 million). The decline was due to pressure on hospital budgets in end-markets arising from unfavorable macroeconomic environment.
Revenue from Trauma franchise increased 8% y/y (to $124 million) in 1Q13. This was ahead of the 4% estimated market growth. Management asserts that the growth was led by increased focus on the high growth trauma and extremities marketwith newer products and focus on sales force expansion.
On May 2, 2013, Smith & Nephew announced an agreement to takeover Adler Mediequip Private Limited and with it, the brands and assets of Sushrut Surgicals Private Limited, a leader in mid-tier, orthopaedic trauma products for the Indian market.
On Apr 2, 2013, Smith & Nephew entered into a definitive agreement to acquire assets of its Brazilian distributor, Pró Cirurgia Especializada (PCE). PCE has been associated with the company for the last 30 years and has distributed its sports medicine, orthopedic reconstruction and trauma offerings in Brazil. The deal is expected to close in the second half of 2013.
On Mar 20, 2013, the company rolled out its new Modular Rail System (MRS) for external fixation and deformity correction. The concept of MRS was developed by Dror Paley, MD, of the Paley Advanced Limb Lengthening Institute at St. Mary’s Medical Center in West Palm Beach, Fla. Based on the body’s ability to generate new bone tissue, MRS is specifically designed to correct bone deformities, malunions, non-unions and limb length discrepancies.
On Mar 19, 2013, Smith & Nephew launched its Journey II Bi-Cruciate Stabilized (BCS) knee replacement at the American Academy of Orthopaedic Surgeons (AAOS) meeting in Chicago. Smith & Nephew had earlier won the European CE Mark approval for its Journey II BCS knee replacement in 2012. The company also initiated a limited market release of the product that year.
The Journey II BCS knee incorporates Smith & Nephew’s VERILAST Technology. The Journey II BCS knee comprises two wear reducing materials – the company’s proprietary OXINIUM alloy along with a highly-cross-linked plastic liner. This in turn reduces concerns associated with implant wear versus other regular bearing couples available in the market.
Advanced Wound Management (AWM) global
The Advanced Wound Management segment supplies a range of products and clinical support services for the treatment of chronic and acute skin wounds. With the acquisition of BlueSky, Smith & Nephew gained access to a series of products that treat chronic wounds such as diabetic ulcers, post-operative, and hard-to-heal wounds using Negative Pressure Wound Therapy (NPWT) and a range of negative pressure pumps and wound dressing kits. There are also products for the treatment of wounds such as burns and invasive surgery that impact the wider population.
Advanced Wound Management revenue was $315 million in 1Q13, up 12% y/y on an underlying basis, versus market growth of 2%. Excluding the impact of the Healthpoint acquisition, AWM revenues inched up 5% y/y. Revenues in the U.S. shot up 28% y/y. The company witnessed 1% growth in the Other Established Markets despite softness across Europe. The Emerging and International Markets recorded 29% growth.
Under AWM, advanced wound care revenues increased 1% to $200 million on the back of exudate and infection management products. Revenues of advanced wound devices improved 26% to $48 million as Smith & Nephew continued to gain market share in NPWT and sustained momentum in the Japanese market.Advanced wound bioactives revenues were $67 million, up 49% from 1Q12 on the back of gains from the inclusion of Healthpoint.
On Jun 18, 2013, the company unveiled a strategic partnership between its Advanced Wound Management (AWM) franchise and United Drug Medical. This new partnership, effective Jun 1, 2013, will promote Smith & Nephew’s IV3000 range of cannula dressings in the UK. As per the partnership, United Drug Medical will be liable for sales, customer service and distribution of IV3000 in the UK. Additionally, IV3000 clientele will gain access to higher level of support and resources. The company will stress on in-use training and education for the product line.
Guidance: Smith & Nephew does not expect any material change in the current market dynamics. The company envisages AWM revenue growth to exceed market growth rate. For FY13, the company expects Healthpoint growth to be more than 20%. For the ASD segment, trauma sales are likely to surpass market growth rate whereas, knee and hips franchise are expected to grow below the market growth rate. On the other hand, sports medicine and arthroscopy units are likely to grow at the market growth rate.