The Investment Column: S&N has some aces up its sleeve

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The Independent Online
ON THE face of it Smith & Nephew offers few attractions for investors. Profits fell by 12 per cent to pounds 161m in 1997 due to damaging impact of the strong pound and the squeeze on European health budgets as European monetary union approaches.

Earnings are likely to be flat in 1998 as the rise in sterling continues to bite, with more than 80 per cent of its earnings coming from overseas. S&N has put aside at least pounds 500m to spend on acquisitions but it has failed to find anybody to buy at a decent price.

Nor can shareholders look forward to a special dividend or share buy- back. And this perennial bid target has, conspicuously, failed to attract a takeover offer.

But S&N has several aces up its sleeve. Its big hope is Dermagraft, its revolutionary bio-engineered skin derived from the discarded foreskin of babies. S&N predicts it will bring in revenues of at least pounds 150m within three years by helping to cure foot ulcers for diabetics.

If it can be applied to other problems such as leg ulcers or cartilage injuries then it has the potential to transform S&N's finances, although this is years away.

Meanwhile S&N's profits should pick up in 1999 as the effect of sterling diminishes and the investment in Dermagraft begins to pay off. The European healthcare market remains tough, but there are signs of some improvement in the US following S&N's shake-up of its sales and marketing set up.

And, while it is sensibly cutting costs by pounds 25m or so a year it is not scrimping on its research and development budget, which can only help its long-term growth prospects.

Dresdner Kleinwort Benson forecasts current year profits of pounds 161m, putting the shares, which fell 2.5p to 173p yesterday, on a prospective p/e ratio of 17.

That looks about right for now, but if Dermagraft takes off the shares will begin to look cheap.