S&N remains comparatively dull

The Investment Column

It's hard to knock Smith & Nephew. The healthcare company has excellent product ranges, good geographical diversity and fine margins, typically at almost 18 per cent. If this were an engineering company or a food producer, such vital statistics would look comely. Unfortunately, Smith & Nephew is usually compared to pharmaceutical stocks like Zeneca which achieve earnings growth averaging 15 per cent and margins in the heady 30s. Compared to this, S&N's 5 per cent sales growth ex-currency and 3 per cent underlying profit growth in the half year to June is pedestrian and explains why it has been a worthy, but dull investment.

There are factors that could potentially get S&N's share price going.

One, already under way, is a shift from competitive low-margin medical devices and bandages to more innovative and quasi-pharmaceutical products. S&N is spending around pounds 35m a year on research and development to stay ahead of the competition. In the half year, orthopaedic implants were boosted by a new generation of knees and endoscopy by some novel keyhole surgery devices.

These sorts of products should allow S&N to demand higher prices in the key US market, though pricing pressure is easing there. The big hope, though is Dermagraft - artificial skin in a bag which speeds up healing of diabetic leg ulcers. The product, costing a hefty pounds 6m this year to launch, will hit the UK in October and could be approved in the US by early 1998. Chris O'Donnell, S&N's new chief executive, expects Dermagraft to make a small loss next year, but hopes for sales of pounds 150m by 2001. Some analysts think it could double that.

The problem is persuading healthcare groups to pay a hefty $3,000 for a course of treatment. In Europe, a third of the world market, fixed budgets could make acceptance of this product difficult. Preparation for monetary union is freezing healthcare spending,flattening S&N's continental European sales this half. The competition also looks worrying, particularly Novartis's Apligraf.

What would undoubtedly help S&N's shares is an acquisition. Mr O'Donnell has talked about a wish list, including Roche's orthopaedic business. But though S&N could borrow around pounds 500m, anything bigger would involve equity. With a host of groups hunting for good healthcare acquisitions, it would have to pay through the nose for anything interesting. Of course, S&N itself could be a bid target, though that has been talked about for years and never materialised. Given all that and the currency problem - a pounds 22m hit in the full year - it's hard to see what will galvanise S&N's shares in the short term.

Lehman Brothers are forecasting pounds 160m pre-tax profits for the full year rising to pounds 199m in 1999. The shares, up 1p to 175.5p are on a forward p/e ratio of 16.4 times this year falling to 14 times in 1999. Fair.

General Accident is top of the class

General Accident, the last of the four composite insurance groups to report interim figures, lived up to its reputation yesterday as the best of the bunch. Operating profits of pounds 260m, the most sensible measure struck before investment gains, compared favourably with both last year's pounds 193m and brokers' expectations.

Of the four, General Accident was the only company to actually make a profit from its UK underwriting.

Not only did it end the half in the black, but it managed an increase in profits from pounds 11m to pounds 19m, despite a marked deterioration in insurance rates during the period.

It has done that by getting the basics right, pricing premiums in order to make a profit and not worrying unduly if that means a fall in volumes. Premium income fell slightly in sterling terms and only rose 4 per cent in original currencies.

Elsewhere, underwriting discipline is less in evidence but in the key US market, General Accident's second-largest territory, there was a dramatic improvement from an pounds 80m loss to one of only pounds 48m. The full impact of a cost-reduction programme is yet to show through, so the improvement should continue.

General Accident was the first composite to restructure its business after the insurance industry's dark days at the end of the 1980s and it has remained an innovator. It was the first to pull out of insuring so- called hot hatches such as the Golf GTi and in 1992 it withdrew from the competitive commercial car fleet market.

In life assurance, a growing proportion of the whole, General Accident is benefiting from the integration of last year's acquisition, Provident Mutual. That appears to have been a good deal, struck before prices in the sector really took off this year.

So General Accident is top of the class in performance terms - sadly it is also out in front on most valuation measures. At 947.5p, up 2.5p yesterday, the shares stand at a chunky 21 per cent premium to net assets per share of 784p. That is more than its peers and a dividend yield of 4 per cent, on a forecast full-year payout of 37.7p, also makes it at least as pricey as the rest of the sector. It is the price for quality, however, and the shares are well underpinned at their current level.

New chief should help Glynwed

Glynwed, the engineering group best known for its Aga cookers, has had a torrid time of late. For more than a year its shares have been plunging, forced down by a combination of the strong pound's impact on exports, the market's lack of enthusiasm for engineering stocks and the City's reservations about the group's management.

In the year to July, the shares underperformed the market by 50 per cent and though they have enjoyed a limited bounce recently they are still on a puny rating. The question now is whether the poor run will continue or whether the shares have been oversold.

There were some grounds for encouragement yesterday, though not all the issues have been addressed to the market's liking. Pre-tax profits for the six months to 28 June were 9 per cent higher at pounds 44m, though the strong pound knocked pounds 4m from the total and is predicted to make a pounds 10m dent in the full-year numbers.

As for the management structure, Bruce Ralph, the chief executive who has attracted some criticism, is stepping down next year. His replacement, finance director Tony Wilson, is well regarded but hardly a new broom as he has been with Glynwed for more than 20 years.

Investors have been frustrated by the pace of change in business mix but Mr Wilson was promising more action yesterday. The loss-making Wednesbury Tube business has been sold, as have several smaller operations.

The company is talking about further disposals and acquisitions of up to pounds 100m concentrating in the US catering equipment market. These are more likely to be funded by debt than equity, though if the price recovers the company is not ruling out a share issue.

Though profits in the consumer and construction division fell by pounds 1m in the first half due to margin pressure on construction products, trading was better in July and the windfall factor should boost sales of Agas and Rayburn range cookers, which retail at pounds 8,000 and pounds 5,000 respectively.

On forecasts of pounds 90m for the current year and pounds 100m the next the shares, down 10.5p to 241.5p, trade on a forward rating of 10 falling to 9.

At these levels the shares are starting to look a decent bet. Either the current management will sort out the problems, or someone else will do it for them.

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