British medical device manufacturer Smith & Nephew (NYSE: SNN) has seen its activity recover and should develop in the coming years.

Stocks aren’t cheap but I think they offer fair value for a company with long-term growth prospects in an attractive sector.

Business performance has improved significantly

The annual results were published in February. Revenues, profits and profit margins all improved significantly over the prior year. This largely reflects the company’s exit from pandemic-era challenges (revenues were just 1% above 2019 levels, while earnings per share were 13% lower), but this remains an important and welcome achievement.

However, there are also signs that the company’s business is in growth mode and not just recovering ground lost during the pandemic. In its first-quarter business statement last month, the company said underlying revenue was up 5.9% year-on-year, although currency translation reduced the reported figure. at 3.3%. All three business divisions reported underlying revenue growth. Similarly, emerging and developed markets saw underlying revenue growth. He said he was on track to provide his guidance for the year (although personally I think if a company can say that on a quarterly basis then maybe their targets aren’t not demanding enough).

Thus, the company is growing and reiterated its expectations for future growth. I previously explained why I am disappointed with the company’s growth strategy. Whether my skepticism is warranted or not, for now, the company’s revenue growth looks set to continue. The growth drivers I see are the company’s strong growth in end-market demand and its attractive product portfolio.

The company’s sports medicine and ENT division, for example, has been a growth engine in recent years, with the exception of pandemic-hit 2020. The overall trend, however, is clearly upwards, as this chart shows.

I also think that the company’s increased R&D spending should help growth. Indeed, in its annual results, the company noted that “we are beginning to see our increased investment in R&D pay off.” So while I have my doubts as to whether the growth strategy as it stands can deliver at the level that management has guided, I see certain growth drivers that should push revenue up in the years to come. come.

The dividend will likely begin to rise modestly again

Currently the dividend yield is 2.4% which is decent, but there are currently much more attractive dividends in the UK market.

However, Smith & Nephew has maintained its dividend throughout the pandemic and I expect it to return to its pre-pandemic trend of annual increases, likely this year given the resumption of business.

Risks

I think one of the risks the stock price faces is the company’s ability to execute its strategy successfully, especially when it comes to growth.

I have previously outlined my concerns about the growth strategy, which I consider to be somewhat ill-conceived and lacking in substance. The company’s growth history has been inconsistent and its end markets continue to be rocked by pandemic-related demand shocks. As the company notes, its goal of “4% to 6% underlying revenue growth by 2024” is “structurally ahead of historical levels,” but I don’t yet see a compelling strategy that would help the company. company to improve its historical balance sheet. One way to do that would be to sacrifice profitability, which I don’t think is attractive.

I see this as a risk because the current valuation, in my view, presupposes a long-term growth story, however modest. Having set what I believe to be a fairly ambitious goal for the business, with limited reason at this stage to confidently believe that it will be achieved, I would not be surprised if, over the next 24 months, we achieve at least one profit warning. , or lowered expectations. This could hurt investor sentiment towards the stock.

Valuation remains an attractive entry point

In my last company post, in January, I switched to a buy rating. Since then, the shares have risen 3%.

The shares currently trade on a price-earnings ratio of around 27. The company is targeting underlying revenue growth of 4-5% this year, but did not provide detailed earnings guidance. But if the company at least regains its pre-pandemic earnings per share (which had actually declined for several consecutive years), the forward-looking price-to-earnings ratio is still in the low 20s.

This compares favorably to the current P/E ratio across a range of rivals, as this chart shows.

Chart compiled by author using data from Google Finance

I don’t think it’s cheap but I consider it a fair value. Smith & Nephew is well established in a profitable industry, it has started to put the pandemic firmly behind it (although China could still prove to be a sting in the tail for 2022) and has growth plans in the years to come. come. This could drive earnings and forward P/E up for several years, so maybe mid to high teens. I see the value here from a long-term perspective.