Company Reports

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound care markets. Though the company is substantially smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its hip implants and knee replacements. For example, its Oxinium technology has demonstrated lower rates of revisions in hip replacements. The firm has also commercialized Regeneten, an implant that facilitates the growth of tendon-like tissue.

Smith & Nephew’s fourth-quarter performance offered a solid finish to 2023. With full-year results largely consistent with our expectations and our 2024 estimates bounded by management’s outlook, we’re leaving our assumptions and fair value estimate unchanged, although we plan to adjust the local shares for foreign-currency movement. The firm continues its blocking and tackling that has returned the orthopedics business to growth and bolstered results in sports medicine and advanced woundcare. This remains a work in progress, and we anticipate the firm to reap rewards in 2024 and 2025. We see little to change our view of Smith & Nephew’s narrow economic moat. Though the firm is considerably smaller than rivals Stryker, Zimmer Biomet, and Johnson & Johnson, it still benefits from high switching costs.

Smith & Nephew’s abbreviated third-quarter results displayed solid improvement that leaves the firm on track to meet our full-year revenue expectations. We’re holding steady on our fair value estimate and consider shares of this narrow-moat company undervalued. Quarterly revenue rose 8% in constant currency, driven by strength in trauma and extremities, as well as sports medicine. As seen with other orthopedic devicemakers, Smith & Nephew’s shares came under significant pressure since late summer as investors became preoccupied by knock-on effects of the GLP-1 therapies for weight loss. Considering osteoarthritis is driven by a mix of genetic predisposition, joint trauma, and lifestyle factors influencing wear and tear in addition to weight, we think it’s unlikely that GLP-1 use will substantially reduce the demand for joint replacement. Because arthritis is a progressive disease, we think it’s more likely that GLP-1s could cause some patients to delay the need for joint replacement, but that many of them will eventually undergo procedures.

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound care markets. Though the company is substantially smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which it contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics.

The uptick in U.S. medical utilization provides a favorable backdrop for medical device firms as the rest of 2023 unfolds. However, we think Smith & Nephew may not be able to fully capitalize on these conditions, as it remains hampered by some operational issues. Despite the near-term speedbumps, Smith & Nephew remains a sizable competitor with attractive businesses that should hold their own over the longer run, and we’re holding steady on our fair value estimate. In particular, Smith & Nephew enjoys intangible assets and switching costs that add up to a narrow economic moat. We’ve seen little to change our thinking there.

With CEO Deepak Nath approaching his one-year anniversary at Smith & Nephew, 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.

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound care markets. Though the company is substantially smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which it contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics.

Narrow-moat Smith & Nephew posted decent third-quarter trading results that largely fell within our expectations, and we’re leaving our fair value estimate unchanged. The company delivered quarterly 5% underlying revenue growth, thanks to strength in advanced wound care, as well as the sports medicine and arthroscopy segment. The orthopedic business offered more muted 2% growth in the quarter. As seen with the firm’s key orthopedic rivals, Smith & Nephew racked up robust growth in knees and hips in the U.S., while revenue growth outside the U.S. remained under pressure.

Smith & Nephew posted second-quarter results that displayed sequential softness following relatively strong performance in first quarter, and we’re modestly lowering our fair value estimate to $38 per ADR (GBX 1,567 per share) after trimming our margin expectations for 2022 and 2023. Nonetheless, we think the market reaction to management’s lower outlook is exaggerated. The firm remains on track to meet our estimates for flat top-line growth in 2022, and our primary adjustments involved tweaking expenses for the next 24 months. Though we remain confident in the firm’s narrow moat, management’s comments about the challenges in its orthopedics business underscores the negative moat trend we’ve given Smith & Nephew.

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound-care markets. Though the company is smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which it contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics.

We’re placing Smith & Nephew under review as we digest second-quarter revenue growth and implications of supply chain disruptions and the impact of input shortages. We plan to publish our updated perspective shortly.

Narrow-moat Smith & Nephew posted abbreviated first-quarter results that showed signs of recovery as the pandemic recedes, which fits with expectations for the full year and we’re holding steady on our fair value estimate. The firm delivered 6% quarterly revenue growth year over year, which we view as strong, especially considering the prior-year period also featured 6% top-line growth. Part of this strength was driven by the faster-growing sports medicine and ENT product areas, which skew toward outpatient settings and ambulatory surgical centers, which have proven less affected by COVID-19 surges. Strong quarterly growth in the advanced wound management segment (up 8% year over year) was also impressive, and we see it as a positive sign that non-pandemic surgical procedures have resumed. Management indicated that even Europe, which has lagged behind the U.S. in its recovery of procedure volume, has seen revenue approach its pre-pandemic levels most recently.

We’ve modestly lowered our fair value estimate on Smith & Nephew to $40 per ADR (GBX 1513 local share class), from $43 (GBX 1534), after adjusting our assumptions slightly downward for lower profitability from the orthopedic segment as Smith & Nephew assertively pursues expansion in ambulatory surgical centers, as well as higher input and transportation costs in the near term. In our base case, we continue to assume hips, knees, and sports medicine will return to more normal growth in 2022 as more elective orthopedic, sports medicine, and ENT (Ear, Nose, and Throat) procedures are rescheduled.

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound-care markets. Though the company is smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which it contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics.

The omicron variant weighed on Smith & Nephew’s fourth-quarter results, but full-year performance generally met our expectations on the top and bottom lines, and we’re leaving our fair value estimate unchanged. The typical seasonal strength seen in the fourth quarter failed to materialize thanks to the pandemic, and quarterly revenue was flat year over year in constant currency. Not surprisingly, large joint reconstruction fared worse as those procedures were delayed in hospitals. In contrast, sports medicine, arthroscopy, and ear, nose, and throat procedures, which are generally handled in outpatient settings, held up considerably better. With rising raw material costs and wages putting pressure on the firm, our expectations for 2022 remain on the modest side. We saw little to change our thinking about this midsize firm’s narrow economic moat.

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound-care markets. Though the company is smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which it contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics.

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound-care markets. Though the company is smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which it contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics.

Impressive innovation has allowed Smith & Nephew to carve out a slice of the orthopedic, sports medicine, and wound-care markets. Though the company is smaller than the dominant orthopedic competitors, it has punched above its weight in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which it contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics.

Not surprisingly, Smith & Nephew’s third-quarter weakness in orthopedics was offset by strength in its sport medicine and advanced wound management segments. We’re holding steady on our fair value estimate, as year-to-date results remain on track with our full-year estimates for the firm. As we’ve seen with the other orthopedic device makers, procedure volume was hampered in the third quarter thanks to the delta variant, and we expect to see some recovery in the seasonally strong fourth quarter. However, we recognize that both Stryker and Zimmer Biomet managed to weather tough conditions relatively better than Johnson & Johnson and Smith & Nephew. Nonetheless, we see little to threaten Smith & Nephew’s narrow economic moat and that any changes to the switching costs that support the moat will likely change only gradually and over the longer term.

While we generally applaud narrow-moat Smith & Nephew’s recent strategic decisions and operational efforts, we’re still not highly confident that this midsize competitor will be able to thrive in a market that has become more and more highly consolidated, especially as hospital customers have sought to leverage volume purchases with fewer vendors. We’ve seen little in recent results to shift our intrinsic value, though we’re mindful that increasing transmission of the delta variant could put pressure on the resumption of elective procedure volume in localized geographies as we head into the fall. If this comes to pass, it would knock roughly $1 off our $43 fair value estimate.