Investment column: Smith & Nephew climbs back off the critical list

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The Independent Online
JUDGING BY the recent performance of its shares, Smith & Nephew, the manufacturer of specialist bandages and replacement hips, has come off the sick list.

Like the patients who benefit from its products, the shares took a tumble last year after regulators forced it to extend a skin graft research programme and its markets deteriorated. The group yesterday posted its first set of results since instigating a review to deal with that crisis.

Chris O'Donnell, the chief executive, has bundled together the struggling businesses to focus S&N on orthopaedics (hips and knees), keyhole surgery devices and "wound management" products such as burns grafts. Meanwhile, he's been switching production in the non-core businesses to countries where labour is cheaper. The moves cost S&N pounds 17m in the first half, but the efficiency gains mean there are more funds to invest in the core businesses.

In recent months the shares have reversed their underperformance to the market. The issue now is whether S&N can sustain its market positions. By sales it's number one in keyhole, number two in wound management and number four in orthopaedic. The cost savings from the restructuring are being spent on beefing up its wound management sales team.

S&N also sees areas where its keyhole surgery technology has yet to be applied and is investing 8 per cent of the division's sales to that end. In orthopaedics, currently the largest division, about 5 per cent of sales are devoted to the design of more sophisticated hips and the tools associated with their fitting.

Naturally, there are calls for a merger. Mr O'Donnell says he's open to offers, but the logic of a merger isn't obvious. Most of his sales costs are commissions, so there would be no scale economies in combining sales forces. In any case, with most of the core businesses growing well ahead of their respective markets, and with the troubled activities stabilised, S&N no longer needs a crutch to lean on. SG Securities expects pre-tax profits of pounds 167m and earnings of 10.5p this year, rising to pounds 178m and 11.1p in 2000, putting the shares on a p/e of 17. S&N's markets are intensely competitive, but the evidence suggests it is now meeting the challenge. Buy.