Smith & Nephew, the FTSE 100 medical equipment company, has long been the subject of break-up speculation. But the group, with some help from an activist shareholder, now looks more open to the idea of carving out its biggest business. Management has hinted that while it is committed to its three-year turnaround plan, it may also evaluate some of its strategic options. So with a demerger on the cards, how should investors approach the shares?
The group, which is based in Watford but makes most of its money in the United States, has three main businesses. The biggest is orthopaedics, where it mostly sells hip and knee replacements. This is followed by its sports medicine and ear, nose and throat (ENT) 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 (AWM) business sells treatments for chronic wounds caused by diabetes, venous disease and surgery.
The 168-year-old business has been a disappointing investment over the past decade, delivering a total return of just 27 per cent against 91 per cent from the FTSE 100. Revenue growth has been weak, profit margins have fallen and various senior management teams have come and gone. But S&N’s current boss Deepak Nath, who has been in the top job since April 2022, has been focused on fixing execution and supply chain issues within the business. Nath, who is based in the US, is now two years into a three-year 12-point remedial plan.
So far this has gone reasonably well: full-year results this week showed that annual revenue grew by 5.3 per cent on an underlying basis to $5.8 billion, ahead of forecasts that were downgraded in October. Trading profit rose 8.2 per cent to more than $1 billion, and its margin hit 18.1 per cent, also ahead of previous guidance. All three divisions grew in its last quarter of the year, with wound care up 12.1 per cent, sports medicine at 7.8 per cent and orthopaedics at 6 per cent.
The headline rate for growth in hips and knees in America was particularly strong, at 7.6 per cent and 5.4 per cent respectively. But there is still concern about a longer-term strategy for the orthopaedics business, which is also grappling with a weak market in China, where the government has intervened to push down the cost of healthcare. Analysts at the broker Panmure Liberum have estimated that if S&N’s overall margin surpasses 21 per cent by its 2027 financial year, with sports medicine and AWM only increasing modestly, orthopaedics will come in at around 16 per cent, still well below its rivals.
Since this column last rated Smith & Nephew as a hold last summer, the shares have been on a rollercoaster ride, falling to as low as 918p compared with their current level of around £11.70. Thanks to the most recent break-up speculation the stock is now up 7 per cent since our last tip.
The group now faces a fork in the road: either ramp up progress in its orthopaedics business or cave in to calls for more drastic change.
It would certainly not be the only company in London to slim down — last month the industrial conglomerate Smiths Group announced plans for a demerger, following pressure from the activist investor Engine Capital. In November the FTSE 100 conglomerate DCC announced it would sell its healthcare business to focus on its energy division.
• Smith & Nephew mulls break-up amid activist pressure
There is much to be said for a simplification for S&N, having racked up hundreds of millions of dollars worth in restructuring costs over the past few years. With a forecast price to earnings multiple of just 15.1, it is no wonder that activists are circling. At its heart S&N has a decent business profile, with a specialism in the medical technology sector that should benefit from structurally higher demand as global populations age. But with a long history of multiple faltering turnaround plans, a break-up may be the best route forward for S&N shareholders.
Advice Hold
Why Break-up may be best route forward
Howden Joinery
Howden Joinery, the FTSE 100 kitchen supplier, unveiled a £100 million share buyback plan last week, but a warning that the home renovation market could shrink this year has scared some investors off.
Howden, which was founded almost three decades ago, is a supplier of both kitchen and joinery equipment. It builds cabinets and worktops at its sites, in Yorkshire and Cheshire, and sells its own brand of appliances, as well as some third-party kitchen equipment brands.
Its vertically integrated model has meant the group has built up much chunkier margins compared with other big building merchants — this week it reported it made a gross profit of £1.4 billion in its 2024 financial year on revenue of £2.3 billion, giving it a margin of almost 62 per cent. Meanwhile, the group has been investing heavily in its manufacturing capability, with capital expenditure at £122 million this year, though cash generation has remained strong, with £344 million worth in cash on the balance sheet.
It is an appealing business profile, though the cyclical nature of its market means the shares have been volatile in recent years. A home improvement wave in the wake of the pandemic helped it hit record sales in 2022, but the cost of living crisis then hit the market hard. The company has warned that the kitchen market is likely to contract further this year.
The warning has been enough to knock roughly a tenth off Howden’s market value in the past five days. The shares now trade at a forecast price-to-earnings multiple of 15.8, at a small discount to its five-year average of 17.1. This drop looks far too steep — trading may be difficult this year, but the business has been making good progress in taking market share, with revenue in the UK up 0.3 per cent against last year despite a contraction in the overall market.
With investment in the business rising, strong cash discipline, improving margins and a smart model, Howden should be able to deliver for investors who are willing to hold on during a period of broader weakness in the market.
Advice Buy
Why Attractive model for long-term buyers
