Morning Note: Market news and an update from Smith & Nephew.

Market News

US equity markets drifted lower last night: S&P 500 (-0.4%), Nasdaq (-0.1%). This morning in Asia, markets were generally firm: Nikkei 225 (flat); Hang Seng (+0.9%); Shanghai Composite (+0.3%). The yen and the yield on Japan’s two-year notes climbed after January inflation data. Core CPI cooled to 2%, beating estimates and supporting the case for the BOJ to move toward ending negative rates.

Inflation in UK stores slowed to the lowest since March 2022, according to the BRC, with prices rising 2.5% in February from a year ago. Sterling trades at $1.2689 and €1.1685. The FTSE 100 is currently little changed at 7,684.

The US dollar is just shy of the record it reached during the pandemic and on pace for its best year since 2020. Key pillars of support — from productivity growth to a torrent of flows into American assets — reinforce its dominance as the world’s reserve currency. “There’s zero alternative,” said Themistoklis Fiotakis at Barclays. Gold held steady at $2,037 an ounce.

For the first time in over two decades, it’s cheaper for US blue-chip companies to sell shares rather than debt. If firms begin to rely less on borrowing and more on equity in a sustained way — still a big if — the ramifications for corporate finance and broader markets are significant.

Source: Bloomberg

Company News

Smith & Nephew has today released its 2023 full-year results. The business enjoyed improved execution under its restructuring plan with revenue growth coming in ahead of guidance. For 2024, the group expects robust growth and further margin improvement. Poor operational performance in the past means the shares have consistently traded on a discount to global peers but in response to today’s results they have been marked up by 4%.

Smith & Nephew (S&N) is a medical products company with three specialist global franchises: Orthopaedics, Sports Medicine & ENT, and Advanced Wound Management. We believe the group is well placed to benefit from the increased incidence of obesity and related conditions, such as diabetes and osteoarthritis, given its strong market position in joint replacement, trauma and diabetic ulcer treatment. Meanwhile, the shift to more active lifestyles in some quarters is expected to lead to increased wear and tear on joints and more sporting injuries, a trend which should benefit S&N. Finally, the group should benefit from an ageing population, who consume more medical products and are more prone to chronic diseases, and growth in emerging markets, as a growing middle class look to access higher-quality healthcare and adopt ‘western’ lifestyles and habits.

In the near term, however, the business has been impacted by the continued delay to elective surgeries, supply chain issues, higher input inflation, and the impact on pricing of volume-based procurement in China.

In addition, operational execution at S&N has been poor over the medium term with recurring restructuring charges and under-performance relative to the global rivals. In response, the company is currently part-way through a two-year (12-point) Strategy for Growth focused on fixing Orthopaedics, improving productivity, and accelerating growth in Advanced Wound Management and Sports Medicine & ENT. The group is targeting underlying revenue growth consistently above 5% and trading profit margin expansion to at least 20% in 2025 (vs. 17.5% in 2023).

In 2023, revenue grew 6.4% to $5,549m. On an underlying basis, which strips out the impact of M&A and currency, growth was 7.2%, just above the company guidance of 6%-7%. In the final quarter, underlying growth was 6.4%. The group has made further progress with its improvement plan, particularly in Orthopaedics, where actions to improve commercial execution and product availability are starting to deliver clear returns, albeit there is more to do to enhance performance in US reconstruction. Investment in innovation continues to bear fruit – during the year, there were major launches in robotics, shoulder arthroplasty and negative pressure wound therapy.

By division, the outperformance in Sports Medicine – underlying revenue growth was 10.0% in the year – continued, despite the headwind from a slow China market. In Advanced Wound Management, growth was 6.4%. In Orthopaedics, the rate of growth was 5.7%, as product launches and 12-Point Plan-led improvements drove improved growth. The group continues to make progress along a similar improvement path with its Hip and Knee Implants business.

The group’s Established (i.e., developed) Markets were up 7.6%, with the US (the largest market) up 7.8% and other Established markets up 7.1%. Emerging Markets grew by 1.3%, with China a headwind.

The trading margin rose by 20 basis points to 17.5%, in line with guidance to be ‘around 17.5%’. As expected, the margin in the second half was considerably stronger than the first half. Trading profit rose by 7.7% to $970m, while adjusted EPS grew by 1% to 82.8c.

The company has a robust balance sheet and access to significant liquidity. At the end of the year, net debt stood at $2,257m (2.0x EBITDA), in line with target. The full-year dividend has been maintained at 37.5c (2.6% yield). The company remains committed to returning surplus cash to shareholders over time.

M&A also remain central to the group’s strategy. The company recently completed the acquisition of CartiHeal, developer of Agili-C, a novel sports medicine technology for cartilage regeneration in the knee. The company believes that with its proven superiority to current standard of care, Agili-C has the potential to transform cartilage repair outcomes and strengthen its leadership in sports medicine biological healing. S&N paid $180m on completion, with up to a further $150m contingent on future financial performance.

Looking forward, the company expects positive operating leverage and 12-Point Plan benefits will more than offset headwinds including continuing inflation, 70bps of negative impact from China volume-based procurement within Sports Medicine Joint Repair, and transactional foreign exchange. Guidance for 2024 is underlying revenue growth of 5.0%-6.0% and a trading margin of at least 18.0%. The group mid-term targets unchanged, i.e., underlying revenue growth consistently above 5% and margin of least 20% in 2025.

In terms of phasing, in Q1 the group expects revenue to reflect the tough US comparator from the good start to 2023, as well as a slower quarter from Advanced Wound Bioactives following the strong fourth quarter and one less trading day year-on-year. The business is expected to return to higher growth across the remainder of the year. The full-year margin will be second-half weighted.

Source: Bloomberg