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The FTSE 100’s Smith & Nephew (LSE: SN) jumped nearly 15% on 5 August — the day of its H1 results release. This was extremely well-deserved, in my view.
Trading profit jumped 11.2% year on year to $523m (£393m), outstripping analysts’ forecasts of $496m. Over the same period, revenue was up 4.7%, to $2.961bn. Revenue is the total income made by a firm, while profit is what is left after expenses are deducted.
Its operating profit margin jumped 25% to 14.5%, and its earnings per share (EPS) soared 36.6% to 33.5 cents.
Cash generated from operations climbed 54.3% to $568m, while free cash flow rocketed 528.3% to $244m.
Key drivers behind the figures
These strong figures were broadly driven by a strong recovery in US demand offsetting weaker demand in China.
A fourth consecutive quarter of improvement was seen in the US’s daily sales for the firm’s Reconstruction & Robotics division. And new products launched in the last five years accounted for three-quarters of the firm’s H1 growth.
China remains a risk for profits, as the country continues its rollout of its Volume Based Procurement (VBP) programme. In this, the government bulk-buys drugs via tenders to secure the lowest prices.
Consequently, Smith & Nephew must increase production to drive revenue higher there, which will take time. The company expects the VBP effect to continue this year.
That said, consensus analysts’ expectations are that the firm’s profits will grow by 14.8% a year to end-2027. It is this growth that drives any firm’s share price and dividends higher over the long term.
Additionally positive in the H1 release was the announcement of a $500m share buyback for H2. These programmes tend to support stock price gains.
Is there value left in the shares?
I am never bothered by a big rise or fall in a share price in and of itself. This is because a stock’s price and its value are not the same thing at all.
The former is simply whatever the market will pay for it at any given moment. But the latter reflects the true worth of the firm, based on its underlying fundamentals. So, it is only with value that I am concerned.
I have found the best method of ascertaining this is through discounted cash flow (DCF) modelling. Basically, what this does is to pinpoint where any firm’s shares should be trading, based on future cash flow forecasts for the underlying business.
In Smith & Nephew’s case, the DCF shows that the shares are 37% undervalued at their current £13.41 price.
Therefore, their fair value is technically £21.29.
Will I buy the stock?
The one and only reason why I have not bought the shares is the lack of the dividend yield I want.
Aged over 50 now, I am focused on stocks that generate a yield of 7% or over. This is because I intend to increasingly live off the dividends as I continue to reduce my working commitments.
Why 7%? Because the risk-free rate (the UK 10-year gilt yield) is 4.5%, and shares have risks attached.
Smith & Nephew’s dividend yield is presently 2.2%.
That said, for investors for whom this is not an issue, I think Smith & Nephew shares are worth serious consideration.
