A solid stock offering quality and yield

published 31 May 2012

There are plenty of solid stocks to choose from if you are after quality and a decent yield. One is Smith & Nephew. In May the orthopedics firm reported a better-than-expected 5% rise in first-quarter trading profits. That was thanks to a $150m restructuring undertaken by the CEO Olivier Bohuon.

Sales of replacement knees were up 6% as customers bought its Verilast implants, guaranteed to last for 30 years. Devices for athletic injuries, such as torn ligaments, climbed 7% and are expected to be further boosted by the London Olympics as more people take up sports.

This helped to compensate for a drop in hip parts, as patients continue to put-off operations due to the perceived risks associated with metal-on-metal joints. Elsewhere, trauma products, including metal plates for broken limbs, fell slightly because fewer people suffered accidents during America's mild winter.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

However, the real drag on the stock since 2009 has been patients postponing surgery because of the associated cost and time off work. That said, the US market now seems to be turning. Bohuon thinks the outlook is "better than one could have expected". Meanwhile, the introduction of Western diets into developing economies has triggered a rise in diabetes-related ulcers, opening up an opportunity for S&N's advanced wound-care unit.

One area to watch is described by Mr Bohuon as "a switch from the doctor-led to an admin-led model". That's where a central buyer takes charge and demands big discounts which affect margins.

Smith & Nephew (LSE: SN), rated a BUY by Exane BNP Paribas.

The City is forecasting 2012 turnover and underlying EPS of $4.2bn and 75 cents respectively, rising to $4.3bn and 82 cents in 2012. That puts the stock on a p/e of 12.5. That looks too low for a science-rich group and a possible takeover target. I would value the stock on an 11 times EBITA multiple. Adjusting for net debt (debt less cash)of $28m and a $252m pension deficit generates an intrinsic worth of 720p per share.

S&N faces challenges. These include competition, pricing and austerity- driven pressures. But the rejuvenated board seems to be addressing these head-on. And with a growing world population, baby-boomers entering retirement, emerging markets requiring improved medical treatment and more overweight people requiring artificial limbs, the sector appears to be one of the few to be enjoying a truly secular bull market.

Exane BNP Paribas has a price target price of 725p.

Rating: BUY at 600p

Paul Hill also writes a weekly sharetipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI or phone 020-7633 3634 for more.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.