CPTS Conceptus, Inc. (MM)

Smith & Nephew plc (SNN) reported adjusted earnings per share (EPS) of 18.5 cents or EPADS of 93 cents in the first quarter of 2013, missing the year-ago EPADS of 97 cents. Further, the adjusted results trailed the Zacks Consensus Estimate (EPADS) of 95 cents.

On a reported basis, EPS of 15.7 cents or EPADS of 79 cents in the first quarter missed the year-ago EPS of 17.7 cents or EPADS of 89 cents.

Revenues

Revenues were $1,075 million in the quarter, up 1% (underlying, after considering currency translation, inclusion of Healthpoint growth and exclusion of Bioventus transaction) year over year. Moreover, the top line beat the Zacks Consensus Estimate of $1,064 million. Excluding the impact of the Healthpoint acquisition, revenue decreased 1% on an underlying basis. Two lesser sales-days in the last quarter led to revenue decline of approximately 3%.

On a regional basis, during the reported quarter, revenues from the U.S. and Emerging and International Markets recorded underlying growth of 4% ($460 million) and 19% ($130 million), respectively. The Healthpoint acquisition led the growth in the U.S. market. Growth in Emerging and International Markets was led by robust sales in the Chinese and Middle-Eastern market. The macroeconomic environment in Europe dragged the company’s performance in Established Markets by 5% on an underlying basis ($485 million).

Segments

Smith & Nephew’s business framework comprises two divisions – Advanced Surgical Devices (“ASD”) and Advanced Wound Management (“AWM”).

ASD recorded revenues of $760 million in the quarter, down 2% on an underlying basis, primarily due to fewer selling days. Within this business, Smith & Nephew experienced 2% decline in the U.S. Segment revenues in other Established markets decreased 7% on a year-over-year basis as the situation in Europe continues to remain an overhang. Maintaining the momentum, the company recorded 16% growth in the Emerging and International markets. Also, pricing pressure for the ASD segment remained unchanged in the quarter.

While the knee implant business reported 6% decline in revenues globally, against the market growth rate of (1%), revenues from the hip implant franchise decreased 6% (down 3% excluding the Birmingham Hip Resurfacing system) against market growth rate of (1%). This was mainly due to a strong comparable year-ago quarter.

Smith & Nephew continues to battle headwinds such as timing of the product cycle against other players, sluggish European market and softness in the company’s largest market in Europe — Germany, besides ongoing softness for metal-on-metal franchise for its orthopaedic reconstruction business.

Smith & Nephew recorded 4% growth in its sports medicine joint repair franchise, while arthroscopic enabling technologies witnessed 7% downfall on a year-over-year basis. The decline was mainly on account of pressure on hospital budgets in end-markets. The trauma business maintained its positive momentum and recorded 8% growth, ahead of the market growth rate of 4%.

AWM recorded strong growth of 12% (underlying) year over year to $315 million in the quarter against 2% market growth rate. Excluding the impact of the Healthpoint acquisition, AWM revenues inched up 5%. Revenues in the U.S. surged 28% on a year-over-year basis. The company witnessed 1% growth in the Established Markets despite softness across Europe. The Emerging and International Markets recorded a robust hike of 29%.

Under AWM, advanced wound care revenues increased 1% to $200 million on the back of exudate and infection management products. Revenues of advanced wound devices improved 26% to $48 million as Smith & Nephew continued to gain market share in NPWT and sustained momentum in the Japanese market.  Advanced wound bioactives revenues were $67 million, up 49% from the prior-year quarter.

Margins

Gross margin expanded 10 basis points (bps) year over year to 75% in the quarter. The company witnessed a 3.4% rise in selling, general and administrative expenses to $547 million and a 20.9% rise in research and development expenses to $52 million. As a result, operating margin contracted 260 bps to 19.3% in the quarter. Overall, trading profit margin (operating margin after taking into account one-time transactions) decreased 90 bps to 22.4% in the quarter.

Among the segments, ASD trading profit margin improved 20 bps to 24.3% on the back of restructuring efforts. However, the trading profit margin at the AWM division recorded a contraction of 290 bps due to the Healthpoint acquisition.

Acquisition of Indian Company

In a separate story, Smith & Nephew announced an agreement to takeover Adler Mediequip Private Limited and with it, the brands and assets of Sushrut Surgicals Private Limited, a leader in mid-tier, orthopaedic trauma products for the Indian market.

While we await further details on the agreement, the buyout gives Smith & Nephew an opportunity to gain a foothold in the burgeoning trauma market in India. The acquisition will also support the company’s plans to develop offerings for the mid-tier market in India.

Our Take

Smith & Nephew reported a mixed quarter to begin 2013. As expected, the company witnessed slowdown in revenue growth due to sustained weakness in the orthopaedic reconstruction. The softness in the European market, especially Germany was another headwind in the quarter.

Nonetheless, we are encouraged to note the gradual stability in the U.S. market, though the challenging scenario in Europe continues to be an overhang. Notably, the company’s increasing focus on AWM franchise is paying off. We are also encouraged by the company’s focus on the lucrative emerging markets such as China and Middle East.

Accordingly, the stock carries a Zacks Rank #3 (Hold). While we prefer to remain on the sidelines for Smith & Nephew, other medical stocks such as Conceptus Inc. (CPTS) and LeMaitre Vascular Inc. (LMAT), carrying a Zacks Rank #1 (Strong Buy) warrant a look. Hanger Inc. (HGR), carrying a Zacks Rank #2 (Buy) is also expected to do well.
 

 
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