Smith & Nephew has long limped behind its rivals, with the shares delivering a negative total return of 30 per cent in the past five years, compared with an 85 per cent rise in its London-listed rival Convatec. No doubt shareholders are therefore cheering the arrival of Cevian, an activist investor that has built a 5 per cent stake in the business.
The 168-year-old medical device and equipment supplier has frustrated investors: over the past decade, revenues have grown at a compound growth rate of just 2 per cent, margins have fallen and returns have been dismal. There has been a merry-go-round of different management teams, and persistent weakness in its share price has prompted speculation that it could be vulnerable to a takeover. So will Cevian usher in a new era of success?
S&N has three main businesses, the largest of which is orthopaedics, where it mostly sells hip and knee replacements. Its second largest is its sports medicine and ear, nose and throat division, which sells products for joint repair, especially from sports-related injuries, as well as technologies to help with keyhole surgery. The advanced wound management segment sells treatments for chronic wounds resulting from diabetes, venous disease and surgery.
Orthopaedics accounts for about two fifths of the group’s $5.5 billion annual revenue and has around a tenth of the market share for hip and knee implants. But it has struggled since the pandemic, when hospitals prioritised Covid patients over surgeries such as hip operations. Meanwhile, its competitors are much larger, with its biggest three rivals in the sector accounting for about three quarters of the market share between them.
Deepak Nath, the S&N chief executive, who took over in April 2022, has been focused on fixing execution and supply chain issues within the group. Nath, who is based in the US, set out a 12-point turnaround plan two years ago designed to reduce overdue orders, launch new products and improve productivity.
Almost half its growth last year came from products launched in the past five years, which management has argued shows that its innovation is working. Overall the group is now targeting underlying revenue growth of consistently above 5 per cent and a trading profit margin of at least 20 per cent next year.
So far, however, progress on its bottom line has been very slow — its trading profit margin stood at 17.5 per cent last year, up only slightly from 17.3 cent the year prior.
Without faster progress, calls for a break-up may re-emerge. The activist American investor Elliott is said to have pushed for a break-up of S&N in 2017 — today the group is still trading at a discount to its peers, by about 10 per cent to its rivals in orthopaedics and 15 per cent to wound care companies, according to analysts at the broker Berenberg.
There is much to be said for a simplification of the business — in the past five years alone S&N has racked up $750 million of restructuring costs, and corporate costs of $403 million last year exceeded $398 million profits from the orthopaedics division.
But Cevian has said it thinks S&N is a “fundamentally attractive business” as it already stands and will likely focus on improving the performance of each segment rather than pushing for a break-up.
It is easy to see why Cevian wants to own the group, with an undemanding forward price-to-earnings multiple of 16 and a compelling growth narrative in the medical technology sector given ageing populations in much of the West. But there is no quick fix at S&N, a break-up does not yet look likely and its various divisions mean there is no obvious industry buyer.
While it is too early to write off S&N’s turnaround, investors should wait for more consistent signs of underlying growth and improvement in its margins before buying into a recovery play.
Advice Hold
Why Await further signs of turnaround progress
BBGI Global Infrastructure fund
Traditional investments in stocks and bonds are integral to the long-term growth of cash savings, but it does mean your portfolio can be limited to just two types of assets. The London market, however, offers ways to invest in infrastructure assets, too.
Take the £985 million BBGI Global Infrastructure fund, which invests in low-risk infrastructure such as transport and healthcare. The fund seeks out assets that have predictable long-term cashflows and with inflation links baked into contracts that are typically with governments or government-backed counterparties. This enables the fund to pay out reliable and growing dividends to its shareholders, with the cumulative growth in its payouts outpacing the UK’s consumer price index since it launched in 2011.
About 35 per cent of its portfolio is invested in Canada, followed by the UK at 33 per cent, 13 per cent in Europe, 10 per cent in the US and 9 per cent in Australia. Most of its investments are in the transport sector, followed by 21 per cent in healthcare, and 12 per cent in emergency service and correctional facilities. Its single largest holding is in the Golden Ears Bridge in Canada, at 11 per cent of the portfolio.
BBGI yields 6.9 per cent and it has a track record of 12 consecutive years of dividend growth since it launched in 2011. But the inflation link across its holdings means that its current portfolio could sustain its progressive dividend policy for 15 years without making any new investments.
The trust is not particularly cheap, with continuing charges of 0.93 per cent as of the end of last year, though thanks to its internal management structure it is lower than the average of 1.25 per cent among rival infrastructure funds. Shares in the trust trade at a 7 per cent discount to their net asset value. This does, however, appear to be moving closer to par, given that its average discount over the past 12 months has been 10.5 per cent.
A target dividend of 8.4p per share for its 2024 financial year, and an implied forward yield of 6 per cent, looks attractive.
Advice Buy
Why Reliable dividend with inflation protection
