Smith & Nephew Unveils Margin Improvement Plan; CEO to Retire

Smith & Nephew PLC, the world’s fourth biggest maker of replacement hips and knees, has embarked on a program to lower costs and improve efficiency which it hopes will improve margins and boost profits by $150 million in 2010.

The details of the margin review accompanied news that chief executive Sir Christopher O’Donnell will retire at the end of June, after 10 years at the helm of the British orthopedics group. As expected, he will be succeeded by chief operating officer David Illingworth.

The group also reported first-quarter results, with earnings meeting expectations. Sales beat consensus forecasts on strong demand for a raft of new products launched in the last six months.

Sales of hips and knees grew 15 percent in the first quarter, faster than the overall market, which grew at 9 pct, S&N said. Strong demand for new products such as the Birmingham Hip Replacement (BHR), a more advanced form of hip resurfacing that was launched in the US for the first time, drove growth.

The earnings improvement program, which aims to grow trading profit margins by ‘at least 1 percent’ a year for the next four years, was as ambitious as most analysts were expecting. However some questioned why S&N was not striving to achieve more, and faster.

That, and the fact that company flagged the impending arrival of competition to the BHR, hit the shares, and the stock closed 1.4 percent down on the day.

‘It was already assumed they would get margin improvement through leverage of costs, and that they would be able to grow margins because their higher margin businesses are growing faster, so if that was already assumed, some have asked why aren’t the cost savings greater,’ Nomura Code Securities analyst Charles Weston said.

‘They are going in the right direction, but maybe the market would have liked to see a little bit more. But they are probably being realistic at what they can achieve and giving themselves a bit of leeway,’ he added.

Presenting the announcement to reporters, CEO-in waiting Illingworth described the margin improvement plan as ‘aggressive, but realistic.’

S&N is still considered ‘mid-sized’ compared to US orthopedic giants Zimmer or Stryker, and has historically generated smaller profit margins, lagging by 300-500 basis points.

‘We believe it will close any gap we may have on any competitors, so we’re very optimistic,’ Illingworth said on a conference call.

The group’s trading profit margin was 20.5 percent in 2006, and the group is aiming to lift that 400 basis points in the next four years.

Peter Cartwright at Evolution Securities described S&N as a ‘fundamental growth story.’

‘There are very few companies that have the luxury to grow top line and margins simultaneously,’ he pointed out.

The company’s orthopedic arm, which makes the replacement knees and hips, and its advanced wound management business will be the major focus of the program.

CEO O’Donnell said the group will seek lower cost manufacturing and that job losses will occur, but that final details have not yet been thrashed out.

The majority of the group’s manufacturing is located in the UK and US. Around 100 people have been notified they will lose their jobs so far, and more are likely.

‘We are clear on parameters, but not on the specifics yet,’ he said, saying the company is likely to increase its presence in Asia.

‘You will see a different footprint for this company in five years time,’ he admitted.

The margin improvement program will cost $200 million, which will be largely incurred over the first three years.

In terms of first-quarter numbers, in the three months to end-March adjusted earnings per share climbed 18 percent to 11.2 pence, while trading profits climbed 19 percent to $148 million. Revenues rose 12 percent to $744 million.

Analysts’ expectations for adjusted EPS ranged from 10.6-12.1 cents, while sales were seen at $703-$735 million.

The company, which no longer provides explicit guidance, said its outlook for the year is unchanged.

S&N shares closed 8.5 pence lower at 616.5, having dropped to 611.5 earlier.

SOURCE: AFX NEWS LIMITED