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

Market News

The Federal Reserve held US interest rates flat and Jerome Powell hinted the Federal may now be finished with the most aggressive tightening cycle in four decades. The yield on the US 10-year Treasury note extended its recent decline to 4.72%. The market also digested the Treasury’s quarterly refunding announcement and a batch of economic data. The Treasury stated it will sell $112bn in longer-duration notes and bonds, more conservative than market expectations of a larger $114bn, as soaring yields for longer-term debt discourage the US government from issuing a larger amount of 10-year and 30-year instruments in favour of shorter-term bills.

US equity markets moved higher in response to the Fed announcement – S&P 500 (1.1%); Nasdaq (1.6%) – and are currently predicted to open another 0.5% higher this afternoon. This morning in Asia, markets were also firm: Nikkei 225 (+1.1%); Hang Seng (+0.8%). The FTSE 100 is currently trading 1.1% higher at 7,421.

The Bank of England will also probably hold rates today at 5.25% as evidence mounts that the economy, labour market, and inflation are weakening. 10-year gilts yields have moved down to 4.43%, while Sterling currently trades at $1.2171 and €1.1475.

Crude ($85.71 a barrel) and most base metals climbed as investors cheered the prospect that US interest rates may have peaked. Gold trades at $1,987 an ounce

The corporate earnings season continues with results today from Apple, Starbucks, Moderna, Eli Lilly, Peloton, and ConocoPhillips.

Source: Bloomberg

Company News

Shell has today released Q3 results which were in line with market expectations and announced another share buyback programme. The shares are up 2% in early trading.

Shell is an international energy company with expertise in the exploration, production, refining, and marketing of oil and natural gas, and the manufacturing and marketing of chemicals. In the ‘upstream’ business (i.e., exploration & production), four fifths of the profit comes from eight core regions: Gulf of Mexico, Brazil, Nigeria, UK, Kazakhstan, Oman, Malaysia, and Brazil. The company is a key player in the LNG market, which is expected to remain tight over the medium term. As part of an integrated energy strategy, Shell is allocating capital to low and zero carbon products and services including wind, solar, advanced biofuels, and hydrogen.

The group’s strategy is to invest in providing secure supplies of energy, while actively working to reduce carbon emissions.  Capital spending will fall from $23bn-$27bn in 2023 to $22bn-$25bn in 2024 and 2025, with the aim to invest $10bn-$15bn across 2023 to 2025 to support the development of low-carbon energy solutions. The group is also aiming to increase efficiency, with annual operating costs reducing by $2bn-3bn by the end 2025.

In the three months to 30 September 2023, adjusted earnings fell by 34% to $6.2bn, in line with the market forecast. Compared to the previous quarter, the result mainly reflected higher refining margins, higher realised oil prices, higher LNG trading and optimisation results, and higher Upstream production, partly offset by lower Integrated Gas volumes.

The group spent $5.6bn on capital expenditure, leaving it on track to meet its full-year guidance of $23bn-$26bn. More than a third of cash capex is being spent on energy transition. During the quarter, the group generated $7.5bn of free cash flow to leave net debt at $40.5bn, with gearing at a comfortable 17.3%.

Shell’s current policy is to return 30%-40% of cash flow from operations (CFFO) to shareholders through the cycle through a combination of dividends and share buybacks. With today’s results, a Q3 dividend of 33.1c a share was declared, 32% above the same quarter last year. In addition, the group has been buying back its shares, with the latest $3bn programme completed and a new $3.5bn programme announced today to be completed by January 2024.

We believe decarbonisation can’t happen at the flick of a switch – oil and gas will remain part of the global energy mix for decades, with demand driven by population growth and higher incomes, particularly in developing countries where the desire for energy intensive goods and services like cars, international travel, and air conditioning is rising. We also believe the production of the materials needed to transition to net zero can’t happen without using hydrocarbons. At the same time, reduced investment in new production, partly because of environmental concerns, is increasingly leading to constrained supply.

In common with all the oil majors, Shell is looking to reduce emissions in a way that delivers attractive returns for shareholders at a time of macroeconomic uncertainty. Despite strong performance over the last three years, the shares remain on an undemanding valuation, both in absolute terms and relative to the US majors, which fails to consider the potential for free cash flow generation and shareholder returns. We believe they also provide something of a hedge against inflation.

Source: Bloomberg

Smith & Nephew has today released a Q3 trading report which was slightly above market expectations, and highlighted evidence of improved execution under its restructuring plan. Guidance for full-year revenue was raised, although the margin outlook was trimmed. Poor operational performance means the shares have consistently traded on a discount to global peers but in response to today’s update, they have been marked up by 4% this morning.

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 charges 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 three months to 30 September, revenue grew 8.5% to $1,357bn, slightly better than the market forecast of $1,341m. On an underlying basis, which strips out the impact of M&A and currency, growth was 7.7%, an acceleration versus the 7.3% generated in the first half and ahead of the market expectation of 6.5%. A sequentially softer quarter had been expected given the tougher year-on-year comparatives.

The group has made further progress with its growth improvement plan, particularly in Orthopaedics, where actions to improve commercial execution and product availability are starting to deliver clear returns. Investment in innovation continues to bear fruit – during the quarter, the group saw the first surgery with its new AETOS Shoulder System and launched its leading REGENETEN Bioinductive Implant in India and Japan.

By division, the outperformance in Sports Medicine – underlying revenue growth of 11.1% – continued, driven by good growth across most markets offsetting weakness in China. In Advanced Wound Management, growth slowed to 3.6% with double-digit growth from the negative pressure portfolio but a slower quarter from Advanced Wound Bioactives. In Orthopaedics, rate of growth accelerated to 8.3%, as product launches and 12-Point Plan-led improvements drove higher growth from Trauma & Extremities (+10.4%). The group continues to make progress along a similar improvement path with its Hip (+3.5%) and Knee Implants (+5.7%) business and expects improving results to follow in the coming quarters.

The group’s Established (i.e., developed) Markets were up 7.4%, with the US (the largest market) up 7.2% and other Established markets up 7.8%. Emerging Markets grew by 9.2%. Within this, China was a headwind as a weaker quarter in Sports Medicine offset a return to growth in Hip and Knee Implants as we fully lapped the impact of Volume Based Procurement. 

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 half-year stage, gearing was 2.3x net debt to EBITDA, with the group targetting 2x by the year-end. The half-year dividend was maintained at 14.4c, leaving the group on target to generate a full-year yield of more than 3%.

The group has previously announced its Chief Financial Officer is to step down. Today, the group has highlighted that John Rogers, former CFO of WPP (and previously J Sainsbury) will be CFO-designate with effect from 1 December.

The group has tinkered with its full-year guidance. Underlying revenue growth is now expected to be towards the higher end of the existing guided range of 6%-7%, slightly above the current market expectation of 6.4%. The trading margin is now expected to be ‘around 17.5%’, a slight reduction from the previous guidance of ‘at least 17.5%’, reflecting headwinds from China. The margin in the second half is expected to be considerably stronger than the first half, providing some uncertainty over whether the guidance will be achieved. However, we note current consensus is 17.5%.

Source: Bloomberg