Overall, FTSE 100 stocks have persevered through the recent market volatility relatively unscathed. In fact, over the last 12 months, the UK’s flagship index is actually up around 2%, not including any additional gains from dividends.
However, not all of its constituents have fared so well lately. Shares of Smith & Nephew (LSE:SN.) have dropped by almost a quarter since April and are still trading at a price that’s half of its pre-pandemic levels.
While it has had its fair share of problems lately, investors are growing increasingly concerned about the impact of powerful new weight loss drugs, namely Ozempic and Wegovy.
However, this pessimism might have created a perfect buying opportunity for long-term investors. So let’s take a closer look.
Righting the ship
Smith & Nephew is a medical devices business known primarily for its orthopaedic solutions. When the pandemic struck, hospitals shifted focus to tackling Covid-19 patients, resulting in a mass delay in elective knee surgeries. This build-up was felt across the sector, with other leading firms including Intuitive Surgical seeing rapid declines in demand.
Investors eagerly waited for the storm to blow over and see the build-up of backlog turn into a new tailwind. For many businesses, that’s precisely what happened. But for Smith & Nephew, growth has failed to live up to expectations.
The company’s inefficient structure led to supply delays. And surgeons who’ve been trained in implanting the company’s products have subsequently had no choice but to switch to a competing product.
This is the exact problem new CEO Deepak Nath is trying to fix. He’s redesigning the corporate structure of this FTSE 100 giant away from its regional franchise model to having three distinct global business units, each with its own chief operating decision maker.
Whether or not this move will deliver the growth and margin expansion that management guidance is promising has yet to be seen. But if such goals are hit, then today’s forward price-to-earnings (P/E) ratio of 13.2 looks like a bargain. For reference, that’s the lowest it’s been in over a decade.
Risks and uncertainties
Not every analyst is convinced of Nath’s ambitious plans. A repeating theme in recent months has been the potential disruption to Smith & Nephews orthopaedic operations from novel weight-loss drugs. After all, knee-related issues have been historically caused by obesity. And if the world starts getting thinner, demand for knee joint replacement surgery could drop sharply.
Personally, I’m unconvinced by this threat. Apart from the fact that the cost of these new medicines makes them unaffordable for most households, weight loss treatments could open a new avenue of opportunities among patients who were previously ineligible for knee surgery.
The bottom line
While Smith & Nephew has some challenges to overcome, I can’t help but feel the punishment dished out by investors is a tad overblown. As such, there lies the opportunity for a sharp upward correction should the new strategy exceed currently sceptical expectations.
As such, I’m cautiously optimistic about this enterprise. And while the risks can’t be ignored, the seemingly cheap valuation makes the margin of safety quite wide, I feel.
