Smith & Nephew, a prominent player on the FTSE 100 known for its medical devices, has seen renewed discussions around a potential break-up, especially with support from an activist shareholder. The company’s management has indicated a willingness to explore strategic alternatives while remaining committed to its three-year turnaround strategy. With a possible demerger looming, what should investors consider regarding Smith & Nephew shares?

This Watford-based company generates most of its revenue from the U.S. and operates through three principal divisions. The largest division focuses on orthopaedics, primarily selling hip and knee implants. This is followed by its sports medicine and ear, nose, and throat (ENT) segment which provides products for joint restoration, particularly those related to sports injuries, in addition to technologies for minimally invasive surgeries. The advanced wound management (AWM) sector specializes in solutions for chronic wounds resulting from diabetes, venous disease, and surgical interventions.

Despite its long history of 168 years, Smith & Nephew’s performance over the last decade has been underwhelming, yielding a total return of merely 27%, compared to 91% for the FTSE 100 index. The company has struggled with sluggish revenue growth, declining profit margins, and frequent changes in senior management. However, current CEO Deepak Nath, who took helm in April 2022, is concentrating on addressing operational and supply chain challenges. Nath is currently two years into a comprehensive 12-point remediation plan.

Recent full-year results indicate progress, with annual revenue climbing by 5.3% on an underlying basis to reach $5.8 billion, surpassing previously downgraded forecasts. Trading profit increased by 8.2% to over $1 billion, while the operating margin hit 18.1%, also exceeding earlier expectations. All three business divisions experienced growth in the last quarter, with a notable 12.1% increase in wound care, 7.8% in sports medicine, and 6% in orthopaedics.

The growth in hip and knee procedures in the U.S. was particularly impressive, at rates of 7.6% and 5.4%, respectively. Nonetheless, there are lingering concerns about the long-term strategy for the orthopaedics division, especially as it faces a challenging market in China, where government actions are aimed at reducing healthcare costs. Analysts from Panmure Liberum suggest that if Smith & Nephew’s overall margins exceed 21% by the fiscal year 2027, with only modest growth in sports medicine and AWM, the orthopaedics segment may still lag at around 16%, significantly trailing its competitors.

Since the last assessment of Smith & Nephew shares as a hold last summer, the stock price has experienced considerable volatility, dropping as low as 918p before rebounding to approximately £11.70. The recent speculation about a potential break-up has bolstered the stock by 7% since the previous recommendation.

Smith & Nephew finds itself at a critical juncture: it must either significantly enhance its orthopaedics operations or yield to demands for more substantial restructuring.

This trend of corporate simplification is not unique to Smith & Nephew. For instance, last month, Smiths Group, an industrial conglomerate, announced plans for a demerger following pressure from activist investors. Additionally, DCC, another FTSE 100 firm, expressed intentions to divest its healthcare division to sharpen focus on its energy sector.

There are compelling reasons to consider a simplified structure for Smith & Nephew, particularly after incurring substantial restructuring expenses in recent years. Given a projected price-to-earnings ratio of only 15.1, it’s understandable that investor activists are taking an interest. The core business retains a solid profile due to its expertise in medical technology, which is expected to see heightened demand as the global population ages. However, with a history of uneven turnaround attempts, a break-up may ultimately be the most beneficial option for shareholders of Smith & Nephew.

Advice: Hold

Why a Break-up Might Be the Optimal Path Forward

Howden Joinery

Howden Joinery, another FTSE 100 company specializing in kitchen supplies, recently announced a £100 million share buyback plan amidst concerns that the home renovation market could face contractions this year, which has caused some investor apprehension.

Founded nearly 30 years ago, Howden provides both kitchen and joinery products, manufacturing cabinets and worktops in its facilities located in Yorkshire and Cheshire. Additionally, it offers its own brand of appliances alongside third-party kitchen brands.

The company’s vertically integrated business model has allowed it to achieve significantly higher margins compared to other major building suppliers, reporting a gross profit of £1.4 billion for its 2024 fiscal year on revenues of £2.3 billion, resulting in an impressive margin of nearly 62%. Meanwhile, the group has made substantial investments in its manufacturing capabilities, with capital expenditures amounting to £122 million this year, while maintaining a solid cash position of £344 million.

While its business profile is attractive, the cyclical nature of the remodeling market has led to share price fluctuations in recent years. A boom in home improvement following the pandemic resulted in record sales for Howden in 2022. However, the ongoing cost of living crisis has substantially impacted market conditions. The company has indicated further contractions in the kitchen market may occur this year.

This warning has resulted in a roughly 10% decline in Howden’s market value over the past week. The shares are currently trading at a forecast P/E ratio of 15.8, slightly below the five-year average of 17.1. Despite this decline seeming excessive, the market may be challenging, but Howden has been successfully increasing its market share, evidenced by a 0.3% revenue uptick in the UK compared to the previous year, even amid an overall market decline.

With increased investments, robust cash management, improving profit margins, and an intelligent business model, Howden is well-positioned to deliver value to investors willing to weather the market’s current turbulence.

Advice: Buy

Why Howden’s Long-Term Model is Attractive for Investors