Smith & Nephew Counters Soft 1Q Reconstructive Sales with Strength in Wound Management

Smith & Nephew SNN posted first-quarter results that were largely consistent with our expectations, and we are standing behind our fair value estimate of $58 per share. As we had suspected, the growth of reconstructive products slowed considerably as Smith & Nephew’s new product cycle is waning just as competitors are launching new products. Nonetheless, the firm plans to launch its new knee system later this year, and continued strength in its wound care segment underscores the strength of Smith and Nephew’s narrow economic moat.

In the face of weak hip and knee growth, which were both down 6% year over year, Smith & Nephew relied heavily on stellar growth in its advanced wound management segment to reach total underlying revenue growth of 1% in the quarter. While management estimated the hip and knee markets declined approximately 1% in first quarter, Smith & Nephew appears to have taken it on the chin and lost some market share as key competitors rolled out new reconstructive products. In particular, we expect Smith & Nephew faces further softness in knees as rival Zimmer ZMH ramps up its launch of Persona over the next couple of quarters. In the meantime, Smith & Nephew continues to take advantage of Johnson & Johnson’s JNJ nail recall and saw its trauma business grow strongly at 8% in the first quarter. We expect growth from trauma to remain robust as the firm has beefed up its U.S. sales force by 50 new people.

We were most impressed with Smith & Nephew’s wound management segment, which grew 5% organically over the quarter, while the market saw estimated growth in the low single digits. The addition of Healthpoint’s fast-growing bioactive wound care products has reinforced Smith & Nephew’s strong competitive position in the advanced wound management arena. With strong double-digit growth in this product line, Smith & Nephew’s wound bioactives line is likely to exceed our projection for 17% growth. Nonetheless, we are leaving our fair value estimate unchanged, as adjusting our estimates upward for bioactives growth was not substantial enough to move the needle on our valuation.

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