Smith & Nephew faces difficult Q3 amidst Covid-19 and supply chain pressures

Smith & Nephew plc, the British medical equipment manufacturing company listed on the FTSE100, published their Q3 results on Thursday 4th November for the period ended the 2nd October 2021. In this quarter, Smith & Nephew’s performance was heavily affected by the resurgence of Covid-19 and the Delta variant in the United States alongside the impact of the volume-based procurement rollout in China. The group announced that after the first nine months of 2021, they were narrowing their expectations for the full year; their revenue growth expectations now sit at the low end of previous guidance at around 10-13%, with their trading profit margin around 18-19%.

In this article, I will break down their Q3 update and determine what to do with Smith & Nephew.

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Business Model

Smith & Nephew develop and produce products across three franchises: Advanced Wound Management, Sports Medicine & ENT and Orthopaedics.

In their Advanced Wound Management franchise (which accounts for 30% of the company’s revenues), the company creates products for the treatment of acute and chronic wounds, including leg, diabetic and pressure ulcers, burns and post-operative wounds.

In their Sports Medicine and ENT franchise (which accounts for 30% of the company’s revenues), they produce specialised instruments, technologies and implants, which are necessary to perform minimally invasive surgery of the joints, including the repair of soft tissue injuries and degenerative conditions of the knee, hip and shoulder.

In their Orthopaedics franchise (which is their largest segment, accounting for 40% of the company’s revenues), they create joint replacement systems for knees, hips and shoulders as well as ancillary products such as bone cement.

In terms of customer base, Smith & Nephew’s products in their Advanced Wound Management franchise are sold to wholesalers and intermediaries, while products in the other two franchises are sold directly to hospitals, ambulatory surgery centres and distributors.

This image depicts Smith & Nephew's three franchises, Orthopaedics, Sports Medicine & ENT and Advanced Wound Management. It provides a short summary of each franchise, as described in the paragraph above the image.
Source: Smith & Nephew's FY'20 Presentation

Recent Performance

This table shows Smith & Nephew's consolidated revenue analysis for the third quarter Q3 2021 TO Q3 2020 by franchise. Key points are explained in the paragraph below the image.
Source: Smith & Nephew's Q3 Report

Smith & Nephew released their Q3’21 report on Thursday 4th November. Their Q3 overall revenue was $1,266 million, up 5.5% from the comparable period in Q3’20 and up 1.6% in the comparable period in Q3’19. Smith & Nephew’s revenues suffered in 2020 due to the poor performance of their Orthopaedics franchise, a segment that has caused trouble for Smith & Nephew since the start of Covid-19.

As seen from the table above, their Orthopaedics franchise has fallen from the Q3’20, down -0.7%, with underlying growth of -5.9%. (Underlying growth is adjusted for FX & disposals).

In Sports Medicine & ENT, revenue was up by 8.3% from Q3’20 with underlying growth of 6.5%. The segment also grew from Q3’19, up 3.9% (see Table Two below for Q3'19 figures).

In Advanced Wound Management, revenue was up 12.1% with an underlying growth of 10.9% from Q3’20. The segment was also up 6.3% Q3’19. This was the company’s fastest growing segment in Q3’21.

This table shows Smith & Nephew's Q3 2021 TO Q3 2019 consolidated revenue by franchise and by geography. Key points are explained in the paragraph above the image.
Source: Smith & Nephew's Q3 Report

Q3’21 has been Smith & Nephew’s weakest quarter to date in 2021. Revenue growth has slipped profoundly compared to the first half of the year due to the struggling Orthopaedics franchise. Performance in Orthopaedics was held back by numerous factors.

Firstly, the consequences of the Delta variant on elective surgeries, notably in the US. As seen from the slide below, knee replacement in particular had a large impact YTD from the comparable period in 2019. Excluding knees from the franchise, Smith & Nephew’s Orthopaedic segment grew from 9M’19 by 1.7%. However, the knee replacement segment caused the entire franchise to lag, at -16.8% compared to pre-pandemic levels in the 9M’19. As the US represents around 50% of Smith & Nephew’s business, a decline in elective procedures in this geography has a profound impact on results.

This image shows Smith & Nephew's franchises in terms of revenue growth compared to the 9M'19 (first nine months of 2019). It shows that in their Orthopaedics franchise excluding knees, there was growth of 1.7%. However, their knees segment fell by -16.8%.
Source: Smith & Nephew's Q3 Earnings Call Presentation

Alongside this, the company was also affected by supply constraints, which restricted their ability to benefit from the rebound in elective surgeries during the period. The company’s main global orthopaedics facility, located in Memphis, was affected by the combination of a tight US national labour market and competition for local workers in the industry, resulting in temporary staffing shortages at the facility causing a lag in production.

Secondly, as mentioned previously, there are increasing global shortages in certain raw materials and in electronics. Shortages affecting Smith & Nephew are those in materials such as resin, silicone and then in electronic components and circuit boards. These shortages are likely to persist for some time. Smith & Nephew have stated that they have adjusted production schedules to try and work with this issue. However, this remains worrying.