Hopes for a V-shaped recovery at Smith & Nephew were reinforced yesterday when the FTSE 100 medical equipment maker issued a reassuring trading update.
The update said that it expected underlying revenue to decline by about 29 per cent in its second quarter because of the disruptions to elective surgery.
Although an unimaginable drop before the pandemic struck, the fall is in line with the guidance previously issued.
Also encouraging for investors was that performance improved over the quarter as lockdowns were eased and elective surgeries resumed. Underlying revenue declined by 47 per cent in April, 27 per cent in May and about 12 per cent last month.
Smith & Nephew has become one of the world’s biggest suppliers of medical devices since it was founded in 1856 in Hull, where it has a research and development site. It employs about 17,500 people in 100 countries in divisions encompassing sports medicine, advanced wound care management and orthopaedics.
It has been most hobbled in its orthopaedic reconstruction, sports medicine and ear, nose and throat (ENT) businesses, whereas its wound and trauma businesses have been more resilient. The broadly positive update lifted Smith & Nephew’s shares by 75p or 5 per cent to £15.80½, the biggest riser on the FTSE 100 yesterday.
Nevertheless, the group cautioned it continued to face “significant uncertainty and geographical variation”, and expected its first-half margin would be lower year-on-year.
The revenue declines are also in painful contrast to its guidance issued in February before the sudden expansion of the virus beyond China. Then it had forecast underlying revenue growth of between 3.5 per cent and 4.5 per this year. That guidance was withdrawn in March.
Management has been seeking to lessen the pain by cutting costs by $200 million and reducing production at some factories.
The pandemic is the second shock investors have faced in less than a year. The first was the sudden exit of Namal Nawana, its well-regarded chief executive, in October after only 18 months in the role in a disagreement over pay. His departure raised uncertainty over a revival strategy that had quickly shown symptoms of a recovery.
It involved restructuring to a franchise-led operating model, overhauling more than half the executive leadership and launching a series of bolt-on acquisitions.
Roland Diggelmann, 53, who was promoted to chief executive, has continued the strategy, though.
For those investors looking through the crisis, there is the potential for Smith & Nephew to return to its pre-pandemic trajectory where underlying revenue growth was 4.4 per cent last year, up from 2 per cent in 2018.
Analysts at Morgan Stanley upgraded Smith & Nephew to “overweight” last month and pointed out that the company had underperformed the European medical technology sector by 5 per cent since the Covid-19 outbreak.
The broker expects orthopaedics and sports medicine to recover in one or two quarters, boosted by procedures being delayed rather than cancelled and financial incentives for providers and surgeons to resume activity. A determination among governments to clear the backlog and reduce waiting lists should also help.
The biggest short-term risk is second waves of the virus forcing new lockdowns, as has happened in the US, its biggest market, and further delays to elective surgery.
It is a development investors will hope has not worsened when Smith & Nephew issues its first-half results on July 29.
Advice Buy
Why Potential for prompt post-Covid recovery, aided by strong balance sheet
Law Debenture Corporation
Investors searching for a reliable dividend face slim pickings. Many companies have cut or deferred payouts to protect balance sheets and it is unclear when they will restore them (Louisa Clarence-Smith writes).
Against this backdrop, equity income investment trusts are coming into their own with their track record of long-term progressive dividends. In contrast to open-ended funds, which are linked to underlying revenue, the equity income sector can retain surplus income to continue payouts during times of market stress. In the aftermath of the 2008 financial crisis, 11 out of 14 UK equity income investment companies still increased dividends, according to Investec.
Law Debenture Corporation is an interesting play in this sector. The company, which is listed on the London Stock Exchange, has increased or maintained its dividend for the past 41 years.
Part of its success comes from its unusual structure, as an investment trust with an independent professional services business. The investment trust, which is managed by James Henderson and Laura Foll of Janus Henderson Investors and accounts for about 85 per cent of net asset value, has a focus on UK stocks they believe are undervalued. Its biggest holding is Glaxosmithkline at 4.1 per cent, followed by Ceres Power, Rio Tinto and Royal Dutch Shell.
The remaining 15 per cent comes from the professional services business which provides transaction and governance services to large corporates, law firms, banks and hedge funds. The structure means it is not wholly reliant on the equity market for its revenues. The professional services business has funded 35 per cent of dividends over the past decade.
An increase in the value of that business helped the company raise its final dividend by 50 per cent for 2019. The full-year dividend was up 37.6 per cent to 26p. The board said in June that it intends the 2020 dividend to be at least equal to 2019. It has moved to paying quarterly dividends and is due to pay its first, of 6½p per share, on July 28.
The company’s reserve levels are the most generous in the sector, according to Peel Hunt, so it is in a good position to continue its record of delivery.
Advice Buy
Why Promise of sustained dividend
