Morning Note: Market news and updates from Amazon and Smith & Nephew.

Market News

The US 10-year Treasury note yield jumped by 5 basis points to 4.67% and the 2-year note rose to above 5% after data showing US labour costs grew more than expected reinforced the view that the Federal Reserve would need to keep interest rates higher for longer. Later today, the central bank is expected to hold its key rate and signal no plans for cuts in the near future. The dollar strengthened and gold slipped to $2,285 an ounce.

Interest rate concerns and their potential impact on earnings pushed US equity markets lower last night – S&P 500 (-1.6%), Nasdaq (-2.0%). Amazon (see below) rose by 1% after hours, while weak results from AMD (-7%) and Starbucks (-12%) sent both stocks down after hours.

This morning in Asia, the risk-off mood prevailed in a holiday-thinned session where many markets were shut: Nikkei 225 (-0.3%). Most markets in Europe are also closed today for the May Day holiday. The FTSE 100 is currently trading 0.3% higher at 8,163.

The Bank of England estimates the losses from QE will cost the UK taxpayer £85bn. UK mortgage approvals rose to the highest level in 18 months, although rising mortgage rates now pose a risk. Sterling trades at $1.2485 and €1.1710.

The oil price slipped to $85.20 a barrel with headwinds from a firmer dollar, a surprise inventory build, and Middle East cease-fire prospects.

Source: Bloomberg

Company News

Last night Amazon released strong Q1 results, with a particularly impressive performance from its cloud business. However, guidance for the current quarter failed to impress, as did the lack of a dividend. In response, the shares only rose by 1% in after-hours trade.

Amazon is the global leader in e-commerce and public cloud computing services. The group has pioneered products and services such as Prime, Amazon Web Services (AWS), Kindle Direct Publishing, Kindle, Fire tablets, Fire TV, Amazon Echo, and Alexa. The company plays to the ongoing shift to online retail and the growth in cloud storage.

In the three months to 31 March, net sales increased by 13%, excluding currency movements, to $143.3bn, a touch ahead of the $142.5bn expected by the market. The impact from Leap Year added 120 basis points to the growth rate.

By division, North America sales grew 12% to $86.3bn; International sales grew 11% to $31.9bn; and AWS, reported as a separate division, grew 17% to $25.0bn.

The combination of companies renewing their infrastructure modernisation efforts and the appeal of AWS’s AI capabilities is reaccelerating AWS’s growth rate, which is now at a $100bn annual revenue run rate. The company also announced the extension of AWS and NVIDIA’s strategic collaboration to make AWS the best place to run NVIDIA GPUs, helping customers unlock new generative AI capabilities.

Operating income rose from $4.3bn to $15.3bn, well above the market forecast of $11.0bn. The group generated net income per diluted share up more than three times to 98c, well ahead of the market forecast of 83c. Adjusted free cash flow for the trailing twelve months was $46.1bn, compared to a $10.1bn outflow in the same period last year.

The group provided guidance for the current quarter to 30 June. Net sales are expected to grow by 7%-11% to between $144bn and $149bn, slightly below the current market forecast of $151bn. Operating income is expected to be between $10bn and $14bn (vs. $7.7bn profit last year). This guidance assumes, among other things, that no additional business acquisitions, restructurings, or legal settlements are concluded.

Source: Bloomberg

Smith & Nephew has today released a Q1 trading report. Revenue growth was in line with expected 2024 phasing and the group has reiterated its guidance for the full year. Poor operational performance in the past means the shares have consistently traded on a discount to global peers. In response to today’s results, they have been marked up by 3%.

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. There are also some concerns over the impact GLP1 weight loss drugs will have on the industry which we believe are overdone.

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 undertaking a two-year (12-point) Strategy for Growth plan 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 the first three months of 2024, revenue grew by 2.2% to $1,386m. On an underlying basis, which strips out the impact of M&A and currency, growth was 2.9%. As expected, this was below the full-year target run rate of 5.0%-6.0% due to a tough year-on-year comparative in the US, as well as a slower quarter from Advanced Wound Bioactives following the strong fourth quarter, and one less trading day than the previous year.

During the quarter, the group made further progress with its improvement plan, particularly in Orthopaedics, where there was strong growth across most segments. The company expects the remainder to improve as the year progresses. In addition, the group is increasing the pace of cross-business unit deals into Ambulatory Surgical Centres.

·       In Orthopaedics, the rate of growth was 4.4%, as product launches and 12-Point Plan-led improvements drove improved growth. The group saw continued weakness in its US Hip and Knee Implants business against a tough comparison with last year, but product supply has improved.

·       Sports Medicine generated underlying revenue growth of 5.5% despite continued headwinds from China. Product launches boosted performance in Joint Repair.

·       In Advanced Wound Management, revenue fell by 2%, with sustained good growth from Devices offset by a decline in Bioactives due to expected Santyl volatility following the strong previous quarter.

The group’s Established (i.e., developed) Markets were up 1.3%, with the US (the largest market) down 0.6% and other Established markets up 4.8%. Emerging Markets grew by 11.6%.

As usual, there is no update on the group’s financial position at this stage. We note the company has a robust balance sheet and access to significant liquidity. At the end of 2023, net debt stood at $2,257m (2.0x EBITDA), in line with its target. The full-year dividend was maintained at 37.5c (3% yield). The company remains committed to returning surplus cash to shareholders over time.

M&A also remains central to the group’s strategy. During the quarter, the company acquired 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 has been reiterated: underlying revenue growth of 5.0%-6.0% and a trading margin of at least 18.0%. In terms of phasing, the business is still expected to return to higher growth across the remainder of the year, while the full-year margin will be second-half weighted. The first-half margin is expected to be around 75-125 basis points ahead of the previous year.

Source: Bloomberg