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Shares in the FTSE 100’s Smith & Nephew (LSE: SN) have dropped 15% from their 6 November 12-month traded high of £12.46.
A price fall of this size always prompts me to reassess a stock as it may indicate a significant bargain opportunity to be had. Alternatively, it could just reflect that the firm is simply worth less fundamentally than it was before.
I ran the key numbers to find out which is the case for Smith & Nephew.
The latest results
The 30 April Q1 results showed revenue rose 3.1% year on year to $1.407bn (£1.05bn). This occurred despite the ongoing headwinds for its China-based business.
More specifically, the country continues to roll out its Volume Based Procurement (VBP) programme. This involves the government bulk-buying drugs via tenders to secure the lowest prices.
It means that Smith & Nephew will have to increase production to push up revenue in this market, which will take time. The firm projects the effects of this will last around another year, and this is one risk for the firm.
Another is the effect of the wide-ranging US tariffs announced on 2 April. The firm estimates in its Q1 report that it expects a $15m-$20m net negative impact from these tariffs this year.
However, longer term it is working to mitigate tariff impacts from products and raw materials imported into the US. This involves leveraging its global manufacturing network to ensure the optimal supply chains.
The growth outlook
Despite the US tariffs and China VBP headwinds, it forecasts 2025 underlying revenue growth of around 5%. It projects trading profit margin over the same period to be 19%-20%.
Consensus analysts’ forecasts are that its earnings will increase 16.6% every year to the end of 2027.
Revenue is the total income a company generates, while earnings are what remains are expenses are deducted.
Are the shares a bargain?
On the key price-to-sales ratio the firm looks a bargain at 2.2 against the 3 average of its competitors. These comprise EKF Diagnostics at 1.9, Carl Zeiss Meditec at 2.5, ConvaTec at 3.1, and Sartorius at 4.7.
It also looks undervalued trading at a price-to-book ratio of 2.4 compared to the 3.5 average of its competitors.
And the same is true of its 30.3 price-to-earnings ratio against its peer group’s 63.6 average.
I ran a discounted cash flow analysis to put all these valuations into share price terms. Using other analysts’ numbers and my own this shows Smith & Nephew shares are 17% undervalued at their current price of £10.64.
Therefore, their fair value is £12.82, although market forces could move them lower or higher.
My verdict
Aged over 50, I am towards the latter part of my investment cycle and focused on stocks that pay a very high dividend yield. Smith & Nephew’s dividend yield is just 2.9% compared to the 7%+ minimum I require for these shares. So they are not for me.
However, if I were even 10 years younger, I would buy the stock at the current knockdown price. I believe it has excellent growth prospects that will power its share price – and dividends – much higher over time.
Consequently, I think it is well worth the consideration of other investors whose portfolio it suits.
