Time to take Smith & Nephew profits

London Bridge; First Active
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The Independent Online

After years of limping along, with a sluggish performance and the occasional trip or fall, Smith & Nephew has been given a new lease of life by Chris O'Donnell, chief executive since 1997. Formerly the UK's foremost supplier of sticking plaster, the company is now focused on artificial hips and replacement knee joints. He has transformed the patient.

Results for 2001, released yesterday, were the best sign yet that the group is in rude health. Sales growth – adjusting for the acquisitions and disposals that have accompanied S&N's transformation – was 13 per cent and operating profits from ongoing businesses were 19 per cent better. Better still, margins are edging towards the average in the medical technology industry.

Top of S&N's portfolio of whizzy new technologies, and a main driver of last year's growth, was an artificial knee made of zirconium, which helped the orthopaedics division post the best performance of the group. But endoscopy (supplying products for keyhole surgery) and advanced wound management (which has developed lotions and potions for burns and other hard-to-heal wounds) also put in a strong contribution.

Only rehabilitation – which supplies products for physiotherapy – looked weak. It doesn't have the growth prospects or the profitability of the rest of S&N, so it is likely to be sold or put into a joint venture such as the bandages business last year. Happily, rehabilitation has already attracted bid interest.

Mr O'Donnell said yesterday that he expects a couple more acquisitions of new technology this year and will also increase research spending. In particular, the company is accelerating work on zirconium hips and voice-activated endoscopes.

That decision is a useful reminder of just how dependent the company is on innovative product ideas to generate the 15 per cent annual growth and 19 per cent operating margins it has promised. These are ambitious targets and the share price rise of the past two years has left pretty much no room for error. The company is still marginally undervalued compared to its US peers but it has yet to boost margins to their levels. Up 13p to 413p, the stock trades on 28 times the coming year's earnings. Take profits.

London Bridge

London Bridge Software, which sells debt management applications to financial companies, is one of the few software groups putting up a fight against tough economic conditions.

Strong increases in both the company's consulting and maintenance income helped offset a dip in revenue from licence sales for the year. Clients bought licences for particular projects rather than signing larger, more flexible deals, but at least they are still being talked into spending.

Total sales were £74.1m in 2001, up from £56.7m the year before. Pre-tax profits, at £11.2m before goodwill write-downs, were slightly better than its most recent forecasts, and up from £9.3m in 2000.

The major flies in the ointment seemed to be its operations in Europe and Asia. Profits in Europe fell a massive 54 per cent to around £5m while sales dropped 4 per cent. Encouragingly, though, the US remained strong. Profits there were £6.2m compared with a £3m loss last time on sales of £48.5m, up 62 per cent. Over a third of the company's total sales are recurring and London Bridge also believes it is now better positioned than it was a year ago. It also ended the period with around £21m of cash.

Analysts reckon the company will make a profit of around £14m this year on sales of between £85m and £90m. Earnings estimates of around 6.5p put the shares, up 5.5p to 155.5p, on a forward price-earnings multiple of some 23 times.

While London Bridge has been plagued by jokes it is "falling down", yesterday's figures give cause for guarded optimism. Once the IT market in Europe shows signs of a comeback, investors should considering buying in.

First Active

While Irish eyes were focused on the shenanigans at the Allied Irish Banks, yesterday's annual results from First Active, the Dublin-based mortgage bank, looked unexciting by comparison. No financial black hole. No rogue trading. Just a solid performance in the face of Ireland's vicious mortgage war, where competition has driven margins lower in recent years.

First Active was able to show a strong bounce back in profits in 2001 thanks to a big efficiency drive. It has moved in to a single head office building, bringing together administration activities that had previously been spread out over four sites and 28 per cent more expensive floor space. Its crucial cost-income ratio was brought down to 58.7 per cent from 64.9 per cent in 2000.

Profit before tax was €54.4m, up 32 per cent, and it wasn't just a case of slashing and burning to get there. First Active enjoyed plenty of organic growth, too, since the Irish economy remained buoyant, with low eurozone interest rates giving a boost to sales of home loans. The group lent a record €1.7bn in the year, kept its share of the Irish mortgage book, and benefitted from having sold more loans through its own branches rather than commission-guzzling mortgage brokers.

First Active – whose UK joint venture with Britannic contributed a third of profits – is ploughing its windfall into increased provisions for bad loans, just in case the economy heads more speedily south, but there is still money left over for a share buy-back. With that, and the end of takeover protection next year, likely to provide a floor for the shares, the stock, up 10p to 224p yesterday, is worth buying.

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