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Smith & Nephew and ConvaTec shares boosted by HSBC upgrade

Published: 11:03 26 Mar 2018 BST

Smith & Nephew
HSBC raised its earnings forecast for Smith & Nephew, which makes artificial knees

Shares in Smith & Nephew PLC (LON:SN. and ConvaTec Group PLC (LON:CETC) were given a leg-up on Monday after HSBC turned positive on the medical products companies.

HSBC upgraded both stocks to a ‘buy’ rating from ‘hold’ in a note on the European healthcare equipment and services industry.

Smith & Nephew revenues boosted currency tailwinds

The bank expects Smith & Nephew, which makes artificial hips and knees, to continue to post “steady” 3-4% underlying organic revenue growth this year and next.

Results will be boosted by favourable foreign exchange rates, corporation tax cuts in the US and the company’s US$160mln cost-saving programme, HSBC said, raising its target price on the stock to 1,530p from 1,320p.

"Overall we see Smith & Nephew as the biggest winner in the current currency environment, as it reports in US dollars and has a large cost base in the US, even higher than revenues, making it a beneficiary of current foreign exchange rates from a translational and transaction impact," HSBC said. 

The bank raised its earnings per share (EPS) estimates by 10%, offering an "attractive" 8% EPS compound annual growth rate from 2017 to 2020.

Shares in the company rose 1.05% to 1,312p in morning trade.  

In February, Smith & Nephew reported a 2% increase in revenue to US$4.77bn for 2017 while operating profits jumped 16% to US$934mln (2016:US$801mln), driven by a strong performance in its knee implants business and double-digit growth in emerging markets.

READ: Knee implants helped revenues and profits to kick in at Smith & Nephew last year

The company said at the time that it expects underlying revenues to increase by another 3-4% in 2018, while trading profit margins were forecast to improve by a further 30-70 basis points.

“We do not anticipate Smith&Nephew to experience material growth acceleration (HSBCe 3-4% organic growth), given the stickiness of the underlying markets, lacklustre growth in wound care, limited innovation upside in the hip market and steady performance in knee implants and Sports Medicine,” HSBC said.

“However, we believe that by anticipating conservative US$100mln of the US$160mln cost savings program and tailwind from FX, margins to rise by 200bps till 2022e, plus the US tax reform we look for an 8.5% EPS CAGR (2017 to 2020) at a low 17x 2019e PE (price to earnings), which we regard as attractive.”

ConvaTec turnaround expected

ConvaTec, on the other hand, had a disappointing 2017, with a profit warning in its third quarter results due to supply issues at its production facilities in the Dominican Republic, higher operating expenditure and a slower uptick of new products than expected.

The colostomy bags maker reported a 3.3% decline in 2017 adjusted operating profit to US$456.8mln.

READ: ConvaTec 2017 profits fall on supply issues and lower sales of new products

“However, with supply issues now being almost entirely solved and the long-term structural equity story being intact (highly attractive underlying markets, self-help potential, potential accelerating growth with new products and entering new regions) we upgrade to Buy, with a new target price of 238p (was 240p), which implies 18% upside,” HSBC said, lowering its target price to 238p from 240p. 

The company said in its full year results that while the supply issues related to the advanced wound care and ostomy care business had been resolved, it expected an ongoing impact on its performance in 2018 as a result of backorders and lost orders.

ConvaTec expects organic revenue in 2018 to rise 2.5-3% but sees the underlying earnings (EBIT) margin falling due to its decision to increase targeted investment.

But HSBC believes the 2018 guidance is conservative and sees the recent underperformance in the share price as a buying opportunity.

HSBC said the segments ConvaTec operates in – including advanced wound care, ostomy, continence and critical care – benefit from an ageing population, improving healthcare coverage and rising wealth in emerging markets.

Shares in ConvaTec rose 1.3% to 199.3p.

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