SNN Beats on EPS, Sales Lag

Smith & Nephew ( SNN - Snapshot Report ) reported adjusted EPS of 18.1 cents (EPADS of 90.5 cents) during the second quarter of fiscal 2012, at par with the year-ago quarter and ahead of the Zacks Consensus Estimate (EPADS) of 80 cents.

Revenues were $1,029 million in the quarter, up 2% (underlying, after considering currency translation) year over year, but behind the Zacks Consensus Estimate of $1,048 million. Revenues on a reported basis dropped 4% due to currency headwinds (3%) and the Bioventus transaction. During the reported quarter, Smith & Nephew transferred its Biologics and Clinical Therapies units to Bioventus (with 49% shareholding), resulting in a $251 million gain. Among the different regions, revenues from the US, Other Established Markets and Emerging and International Markets recorded an underlying growth of 2% ($413 million), 1% ($493 million) and 10% ($123 million), respectively.

Segments

Smith & Nephew’s two segments – Advanced Surgical Devices (“ASD”) and Advanced Wound Management (“AWM”) recorded corresponding revenues of $774 million (underlying growth of 2%) and $255 million (up 4%).

Within the ASD business, Smith & Nephew experienced a 2% growth in US, though performance in other Established markets remained flat. Maintaining the momentum, the company recorded 10% growth in Emerging and International markets. While the US market is on the path to stability, European situation continues to remain an overhang.

While the knee implant business recorded a 3% rise globally, in line with the market growth, the hip implant franchise dropped 5% due to persistent headwinds in the metal-on-metal total hip replacement sector. Pricing pressure across these segments remained unchanged compared to previous quarters at -2% (including the effects of the biennial price reduction in Japan), partially offset by mix gains.

The company recorded 10% growth in its sports medicine joint repair franchise, but a 4% drop was recorded in arthroscopic enabling technologies due to customer’s spending cut on visualization equipment. The Trauma business recorded a 3% growth, an improvement from the last quarter. However, after taking into account the loss of US royalties, this unit recorded 5% growth.

AWM recorded growth of 4% (underlying) to $255 million amidst weaker markets in both the US and Europe that grew almost 2%. Revenues from US increased 6%, driven by strong performance of the Negative Pressure Wound Therapy (“NPWT”) portfolio.

While Emerging and International markets recorded 9% growth, non-US Established Markets grew 3%, reflecting strong performance in France, Germany, the Nordics and Australia. Smith & Nephew recorded 4% growth in Exudate Management while Infection Management remained flat.

Expenses

Gross margin expanded 90 basis points (bps) year over year to 74.2% during the quarter. Despite a 1.7% drop in selling, general and administrative expenses and a 2.3% decline in research and development expenses, operating margin contracted 60 bps to 20.4%. Overall, trading margin (operating margin after taking into account one-time transactions) increased 80 bps to 22.7% reflecting positive impact of restructuring undertaken at the ASD unit in the US.

Among the segments, ASD recorded improved trading margins of 120 bps while the AWM unit recorded a contraction of 60 bps. The company is working to control the cost structure, the benefits of which should be realized in the forthcoming quarters.

Dividend Hiked

Smith & Nephew hiked its interim dividend payment by 50% to 9.9 cents per share (49.5 cents per ADS), to be paid on October 30, 2012, to shareholders of record date as of October 12.

Recommendation

We are encouraged to note the gradual stability in the US market though the challenging scenario in Europe continues to be an overhang. Apart from expansion of its portfolio, the company is also working on cost-saving initiatives that are yielding results. We are also encouraged by the company’s focus on emerging markets. However, pricing pressure continues to remain a major headwind. Besides, the competitive landscape is tough with the presence of players such as Zimmer Holdings ( ZMH - Analyst Report ) and Stryker Corporation ( SYK - Analyst Report ) .

The stock retains a Zacks #3 Rank (“Hold”) in the short term.