Market news and results from Smith & Nephew and Tritax Big Box.

Market News

Equity markets fell in the US last night – S&P 500 (-1.4%); Nasdaq (-2.2%) – triggered by strong US labour-market data, with S&P futures currently predicting a further 0.5% drop at the open this afternoon. This morning in Asia, markets were also down: Nikkei 225 (-1.7%); Hang Seng (-0.2%). The FTSE 100 is currently trading 1.2% lower at 7,462.

The yen dropped after the Bank of Japan announced another round of unscheduled JGB purchases. Treasuries were lower – the 10-year yields now 4.15% – while gold trades at $1,937 an ounce.

Former Treasury chiefs Hank Paulson and Timothy Geithner urged US officials to address long-term debt challenges before they become insurmountable. “Our fiscal trajectory is concerning,” Paulson told Bloomberg Television. His successor called for action “before it’s late and hard.” Separately, ex-S&P analyst David Beers warned that some of the problems that prompted his former firm to downgrade the US in 2011 have escalated.

The Bank of England is expected to boost rates again today, with a recent inflation slowdown giving policymakers scope to scale back the size of hikes. Economists forecast at least a 25-bp move to 5.25%, with a strong chance of a repeat of the 50-bp hike seen in June. Markets are now bracing for rates to peak around 5.75% by year end, almost a full point below expectations just a month ago. Sterling currently trades at $1.2690 and €1.1624. The 10-year gold yields 4.45%

Late today, Apple is set to post its third year-over-year revenue decline. Amazon investors will be focused on its cloud computing unit and how the company plans to make money from AI.

Source: Bloomberg

Company News

Smith & Nephew has today released results for the first half of 2023. Profit came in below market expectations, although the group has maintained its full-year margin guidance and raised its revenue outlook. Poor operational performance means the shares have consistently traded on a discount to global peers and in response to today’s update, they have been marked down 1%.

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 outlook remains uncertain due to the continued delay to elective surgeries, supply chain issues, higher input inflation, and the impact on pricing of volume-based procurement in China. As a result, the key issue for the industry is limited pricing power in an inflationary environment.

In addition, operational execution at S&N has been poor over the medium term with recurring restructuring changes and under-performance relative to the global rivals. In response, the company is currently part-way through a two-year (12-point) plan to drive a 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. 17.3% in 2022).

In the six months to 30 June, revenue grew 5.2% to $2.7bn. On an underlying basis, which strips out the impact of M&A and currency, growth was 7.3%, with the rate of growth accelerating in the second quarter. The group’s Established (i.e., developed) Markets were up 8.5%, with the US (the largest market) up 9.0% and other Established markets up 7.7%. Emerging Markets grew by 1.7%.

The continued outperformance in Sports Medicine (underlying revenue growth of 11.0%) and Advanced Wound Management (+7.0%) – representing 60% of the group’s business – has continued. In Orthopaedics (+4.8%), the group’s actions to improve product supply and execution have increased S&N’s ability to benefit from strong elective procedure volumes.

The group has made further progress growth improvement plan and continued to deliver innovative new products, During the half-year, 13 new products came to market, with major launches underway in high growth segments including robotics, shoulder replacement, and negative pressure wound therapy.

The trading margin fell from 16.9% to 15.3%, reflecting expected seasonality and higher input inflation, transactional FX, and increased sales and marketing to drive growth. Although the drop is disappointing, the company highlights the decline is in line with management expectations. In the second half, the company expects a clear step-up in the trading margin as productivity gains come through.

Operating profit grew by 14% to $275m, while adjusted EPS fell 2% to 19.7c. There was a free cash outflow of $82m, primarily due to inventory increase. Performance is expected to improve in the second half as inventory levels start to come down. The company has a robust balance sheet and access to significant liquidity. At the end of June, net debt stood at $2.8m (2.3x EBITDA), with the group targetting 2x by the year-end. The half-year dividend has been maintained at 14.4c, leaving the group on target to generate a full-year yield of 2.5%.

The group has also announced its Chief Financial Officer is to step down in Q2 2024; the Board has initiated an external search for her successor.

The group has increased its full-year guidance for underlying revenue growth from 5%-6% to 6%-7%. Guidance for the trading margin of at least 17.5% has been reiterated as the positive operating leverage from revenue growth, productivity improvements and the early benefits of cost saving initiatives more than offset continuing macroeconomic headwinds from raw material cost inflation, higher wages, and a headwind from transactional foreign exchange.

Source: Bloomberg

Property News

Tritax Big Box REIT has this morning released its first-half results, which highlight an improved industry backdrop. In response, the shares are up 1% in early trading but still trade at a large discount to NAV.

Tritax is a real estate investment trust dedicated to investing in very large logistics warehouse assets, or Big Boxes, in the UK. Over time, the group has evolved from an income-led asset aggregator into an integrated investment and development company. The £5bn portfolio is spread across 76 assets and 51 institutional quality tenants, with a weighted average unexpired lease term of 12.1 years. The largest tenant is Amazon, representing 14.5% of rental income.

Through an 87% economic interest in Tritax Symmetry, the group owns a strategic land portfolio for the development of Big Box assets of more than 40m sq ft (including land options). This provides the opportunity to more than double the company’s existing rent roll over the next decade. The group aims to minimise risk by primarily undertaking developments which are pre-let to a tenant – speculative development is less than 1% of asset value. The company believes these opportunities can be delivered at a yield on cost significantly higher than is currently available from acquisitions of built and let or pre-let forward-funded assets, with a 6%-8% yield target.

We believe the long-term outlook for the UK’s logistics sector remain favourable, supported by the continued growth in e-commerce, the consolidation of logistics networks into fewer, larger, more modern and efficient buildings, the need to build resilience into supply chains, and the increasing focus on ESG. Although the investment market has faltered over the last year, occupational demand has remained strong – there were 10.0m sq ft of UK lettings in H1 2023, in line with 12.8m sq ft pre-pandemic average – and the vacancy rate is 3.4%, with supply of new space now slowing. The level of speculative starts in the market has reduced during the first half of this year. At a time when occupiers need a robust and flexible supply chain, the assets are essential to their business and cannot be easily replicated. We note that property costs are typically as little as 1% of total operational costs for a retailer – more important is having the right location.

During the first six months of 2023, the value of the group’s portfolio fell by 0.2% to £5.05bn, equating to an equivalent yield of 5.3%, in line with the year end. The benefits of development gains and asset management were offset by net disposal activity.

Investment activity has fallen across the market due to the deteriorating economic outlook and interest rate environment. However, the statement highlights that following the rapid outward yield shift in the second half of 2022, asset pricing has shown increasing signs of stabilising during the period, with the CBRE UK Monthly Industrial index recording capital value growth of 1.4% for the six-month period.

Tritax continued to crystalise value through asset sales and recycle capital into higher-returning opportunities. So far this year, the group has completed or exchanged on £235m of asset disposals in line with or above December 2022 valuations (blended net initial yield of 4.4%) and is targetting a further £100m-£200m of disposals in the second half.

The market is seeing strong and diversified occupier demand, combined with historically low levels of availability, leading to rapid leasing of buildings and rental growth. Tritax’s portfolio vacancy is only 1.9% and has fallen further to 1.4% from development letting after the period end. Tritax is currently experiencing 100% occupancy with no customers on payment plans.

The group’s portfolio offers a secure, growing income – 32% of rent is generated by leases having an unexpired term of more than 15 years and 25% from leases expiring within five years of the period end and which provide near-term asset management opportunities.

The passing rent increased by 3.1% to £211.6m, with 100% of rent collected. EPRA like-for-like rental growth was 3.6%. The contracted annual rent roll was unchanged at £224m, as an incremental £4.1m from development lettings and £2.0m added from rent reviews was offset by £6.1m from disposals.

The group sees good prospects for rental growth to exceed inflation over the medium term. 19% of the portfolio is subject to rent reviews in 2023 and a further 30% in 2024. With a blend of inflation-linked (52%), open market (30%), fixed (9%), and hybrid (9%) review types, the group is well placed to capture attractive levels of accelerating rental growth. We note that two open market rent reviews were completed in the first half achieving an average 29.2% uplift. Overall, there is further reversion potential of 21.3% to be captured in future reviews (i.e., £48m).

The growing rental stream means the group can adopt a progressive dividend policy, with the intention to pay out more than 90% of adjusted earnings. The group has announced a Q2 payment of 1.75p, up 4.5%. A similar increase for the full-year dividend would generate a 5.4% yield at the current share price.

On the development front, the group continued to make progress and is seeing ‘near-record enquiries’ on its pipeline. Development completions relating to 2022 construction starts added £10.5m to passing rent and the group currently has a further 2.6m sq ft under construction, of which 65% is pre-let or has been let during construction and which will contribute a further £12.5m to passing rent. The 6%-8% yield on cost guidance has been maintained with 2023 schemes still expected to be delivered in the mid 6%-7% range.

Post the period end, the group acquired Junction 6 Logistics Park, one of the UK’s leading urban logistics estates, for £58m at a 4.6% net initial yield. The asset provides attractive opportunities to grow income in the near term reflected in 6.7% reversionary yield.

The group remains financially robust – the LTV stands at 30.3%, at the lower end of the 30%-35% target range – with substantial covenant headroom. The current weighted average cost of debt is only 2.6%, with 100% of drawn debt fixed or hedged, with an average maturity of 4.9 years. We note the marginal cost of debt of above 5.0%. The group had available liquidity in excess of £550m at June 2023, with no loan maturities until the end of 2024. There is significant headroom under all debt covenants – values would have to fall 50% before the company breached any covenants.

The EPRA cost ratio has fallen from 15.2% to 12.6%, reflecting a 9.8% reduction in administrative expenses and increasing net rental income.

The EPRA Net Tangible Assets (NTA) per share rose by 1.5% to 183p, with the total accounting return of 3.5%. The shares (and the sub-sector) have fallen over the last year driven by rising bond yields and comments from Amazon regarding its pace of growth. As a result, they have moved from a sizeable premium to NTA to a large (26%) discount.

Source: Bloomberg