Smith & Nephew plc

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Smith & Nephew is a global medical technology company, specializing in orthopedics, sports medicine, and advanced wound management. They aim to restore people’s mobility and self-belief.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Smith & Nephew (SNN) is a prominent player in the global medical technology market, organized into three main franchises:

  1. Orthopedics: Focused on hip and knee implants, as well as other technologies used in joint replacement and reconstructive surgery.
  2. Sports Medicine & ENT (Ear, Nose, Throat): This franchise delivers products and procedures for surgical repair, soft-tissue reconstruction, and minimally invasive techniques in otolaryngology.
  3. Advanced Wound Management (AWM): Dedicated to solutions for wound care, including products for chronic wounds, skin and tissue repair, and infection prevention.

A key strategy at SNN is building a franchise model that is focused on innovation, quality, and building long term relationships with its customers and stakeholders. They also focus on sustainability throughout their business.

Historically, the company has grown through a combination of organic growth, acquisitions and strategic partnerships. They also have a major focus on the value-based model, giving importance to patient outcomes and quality over price.

Industry Trends: The medical device industry is large and growing, driven by factors such as an aging global population, an increased prevalence of chronic conditions, and rising healthcare spending. SNN competes in markets where:

  • Orthopedics is influenced by the rising number of knee and hip replacement procedures and the need for advanced implants, but this sector has become more competitive recently and is showing pricing pressure as a result.
  • Sports Medicine market is seeing growth due to the increasing demand for minimally invasive surgical techniques and sports-related injuries.
  • AWM has shown steady growth, partly due to the rising need for specialized wound care, an aging population, and increasing rates of diabetes.

In all these industries, the regulatory environment and healthcare reimbursement policies have a large impact. These factors greatly influence profitability of these companies.

Competitive Landscape: SNN faces competition from other large medical technology companies, as well as smaller, more specialized players. These competitors include:

  • Orthopedics: Zimmer Biomet, Stryker, and Johnson & Johnson.
  • Sports Medicine & ENT: Arthrex, Stryker, and Olympus.
  • AWM: 3M, Mölnlycke Health Care, and ConvaTec.

The company’s global presence means they also compete with regional players within each market. SNN competes on factors such as innovation, product quality and performance, distribution network, brand reputation, pricing, and ability to build long-term relationships with surgeons and healthcare providers. They must be innovative to stay ahead and focus on their R&D and pipeline.

What Makes SNN Different: Smith & Nephew differentiates itself through a blend of product innovation, and a focus on providing high-quality care. They are focused on emerging markets and have committed to a long-term focus in value-based health care.

The company emphasizes advanced digital and robotic technologies to help increase the efficiency of their products and better serve their customers. Their commitment to sustainability also sets them apart and is built into their growth plans.

Financials In-Depth

The financials are reported in millions of US dollars.

  • Revenue: In 2022, the Group generated revenue of $5,215 million, this is a 0.1% increase from the previous year. Their growth has been heavily impacted by the strong dollar and the COVID pandemic, as well as supply chain issues. For 2023 guidance, they expect underlying sales growth to be between 5.0% and 6.0%.

  • Profitability: The reported operating profit was $450 million, this is a 20% decrease from the previous year. While the trading profit margin was 17.3%, this was greatly reduced in the second half of the year because of inflationary pressures, supply chain issues, and the cost of acquisitions. The 2023 guidance projects a strong improvement in trading profit margin.

  • Key Metrics: SNN’s return on invested capital (ROIC) is 7.3%, which is down from previous years but still respectable. This is expected to improve as new products are released and profitability margins improve.

    • R&D expenditure for 2022 reached $345 million, reflecting the company’s commitment to innovation.

    • Their trading cash flow was $901 million, this is up from $593 million in 2021. The company continues to prioritize financial health and liquidity.

    • They delivered a share price dividend of 37.5 cents per share, and a focus on returning value to the shareholders.

Recent Concerns/Controversies & Problems:

  • The company has faced significant challenges recently which have slowed down its financial results. This includes:
    • Global inflation: impacting both revenue and costs. This can be seen in the reduced operating profit and trading profit margin. This has been especially impactful on their higher cost regions, such as the US.
    • Supply chain challenges: increasing the price of their raw materials, production, and transportation. This also delayed product launches, and lowered the sales volume of certain divisions.
    • FX headwinds: In the past year they’ve had high impacts on their revenue, because of a very strong dollar relative to other global currencies.

  • Acquisition Costs: The most important drag on performance was the cost of recent acquisitions that significantly affected the operating and trading margins.

  • Management Outlook:
    • Management acknowledges the current struggles and has a clear plan in place to navigate them effectively. They are focused on increasing profitability through improving pricing, supply chain optimization, cost cutting, and better focus.
    • They also remain committed to long-term growth and shareholder value creation. They highlighted innovation, sustainability, financial health and liquidity as their main areas of interest.
    • SNN has established a 12-point plan to fundamentally change their business, which is focused on strengthening, accelerating, and transforming the business.
Management has stated that they are facing "significant uncertainty" for the foreseeable future, especially concerning their European markets, which have shown the most volatility. They have stated that margins are expected to be impacted until at least the end of 2024 due to higher energy costs.

Moat Rating: 3 / 5 SNN possesses a narrow moat rating. While they enjoy some advantages in certain segments, they do not consistently demonstrate all the characteristics of a wide moat. They benefit from brand recognition, large distribution networks, and patents and trademarks, but they have not proven that these advantages are truly durable given strong and increasing competition within each of their major divisions. They do not have consistently strong cost efficiencies or large, hard-to-penetrate economic moats that would make other companies unable to make a dent in their margins. A summary of their moat by segment would be as follows:

  • Orthopedics: A narrow moat, driven by a strong brand and relationships with surgeons and customers. But, it faces significant competition, and patents can be challenged or expire, eroding those advantages.

  • Sports Medicine & ENT: Narrow moat with some switching costs and technological barriers, but this is becoming increasingly competitive as more companies begin operating in this space.

  • Advanced Wound Management (AWM): Narrow moat with strong market positions and somewhat defensible niche businesses. But pricing can still be more competitive with other providers.

Legitimate Risks that could harm SNN’s Moat

  • Technological Disruption: The emergence of new medical technologies or devices from competitors could diminish SNN’s existing product lineup and could remove its cost advantages.
  • Pricing Pressures: Increased competition or government-mandated price cuts and changes to regulations might erode SNN’s profit margins and revenues. They also have a limited ability to pass rising input prices to their customer base.
  • Product Liability & Litigation: High liability and risk of product failure can affect their overall profitability. For instance, large litigation can put a considerable strain on resources.
  • Acquisition Failures: They have shown considerable integration problems which has lowered its profitability, and also may have trouble fitting and managing any future acquisitions into its existing structure.
  • Global Instability: With operations in numerous global locations, supply chain issues, war, and financial instability in any of the areas may negatively affect the company.

Business Resilience: SNN shows resilience because of a few key factors. They have a well-diversified revenue stream because of their three separate divisions. They are also an established global company with a diversified geographic presence and a long-standing presence in the medical technology sector. Moreover, their ongoing focus on innovation and improving their financial performance will further improve their resiliency.

Understandability Rating: 2 / 5 SNN’s business model is complex due to its three diverse segments and many product offerings. Additionally, there are many regulatory factors that influence the company and its respective markets, that require some specialized knowledge. Finally, the complex nature of medical technology and the medical sales process requires a deeper knowledge of the markets they participate in. This complexity makes it slightly less straightforward for an average investor to fully grasp the company’s dynamics, hence the 2/5.

Balance Sheet Health Rating: 4 / 5 SNN has a healthy balance sheet, with adequate liquid assets for operational and investment activities. They have a good cash flow generating business and also have access to significant external funding when needed, though at increasing rates. Here is why:

  • Debt: Their debt is not high, and although has increased it is still at a level to be considered sustainable, they also continue to bring it down in 2023.
  • Liquidity: SNN has sufficient cash and marketable securities on hand to cover short-term obligations and for strategic flexibility.
  • Cash Generation: The company’s cash flow remains consistently robust, which gives management ample ability to reinvest and return capital to shareholders.

In conclusion, Smith & Nephew is a prominent medical technology company with several strong assets, but they face some clear risks going forward and may have some trouble maintaining high levels of returns on invested capital. However, a focus on value creation and a proactive response to the changing business landscape will help in the future.