Smith & Nephew Sees Early Signs of Turnaround Results but Still Faces Near-Term Challenges in 2023

With CEO Deepak Nath approaching his one-year anniversary at Smith & Nephew SN., the firm seems to be making progress on its turnaround plan, though it has yet to manifest itself in higher top-line growth and profitability gains that we think can be maintained. We’re holding steady on our fair value estimate. While economic profits disappeared in 2020 thanks to COVID-19 damping non-urgent procedures, Smith & Nephew has benefited more recently from the resumption of regular procedure volume, launches of key new products that have filled distinct gaps in the portfolio, and improved operations to address demand. These developments and the strength of underlying switching costs and intangible assets give us confidence that the firm’s narrow economic moat remains solid.

Nonetheless, Smith & Nephew still faces a long path to remodeling operations and the product lineup to support both faster growth and greater profitability, in our view. Additionally, the firm still has to contend with near-term speed bumps in the form of China’s Volume Based Procurement program, foreign exchange headwinds, and inflation. The orthopedic segment has been most affected by these negative factors, and the process of pushing last year’s orthopedic trading margin of roughly 18% closer to historical levels near 30% remains challenging and could take longer than the 2025 timeframe management has suggested. For these reasons, we continue to hold tempered views on operating leverage in 2023.