Assignment FM June2004

8/3/2019 Assignment FM June2004

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Investment market research on Smith & Nephew Plc & Huntleigh Technology Plc

APU

Ashcroft International Business School

Investment Market Research on

Huntleigh Technology Plc

& Smith & Nephew Plc

June 2004


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Executive Summary

Following in-depth analysis of two healthcare companies, Huntleigh Technology plc and

Smith & Nephew plc, FirstSight investment advisors recommends the full investment of

20 million on Smith & Nephew plc. The good financial performanceof Smith & Nephewplc, as elaborated in Chapters 2 and 3, combined with the ageing population, and

anticipated increase in demand in healthcare products for the frail and elderly population,

will ensure a good return on investment. Based on past performance, it is anticipated that

Smith & Nephew plc will outperform the diversified market rate of return of 9.96% and will

even more than double the rate of return expected by Ter Fille Investment Groups

customers of 30.52 million. Smith & Nephew plcs policy of re-investment for growth and

recent acquisition of six major medical devices companies in the last two years are

expected to result in a sharpe increase in share value and shareholders return. The

possible risks that could reduce the expected rate of return are unfavourable fluctuations

in currencies and possible social and political upheaval in other countries. Further

financial analysis predicts that, even with a reduction of 50% on the expected dividend, a

20 million investment in Smith & Nephew plc will still bring the return expected by Ter

Fille Investment Groups customers.


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Executive Summary ................................................................................................................................................... i

Table of Contents ....................................................................................................................................................... i

Chapter 1: Introduction............................................................................................................................................. i 1

Smith & Nephew plc ........................ ........................... ......................... .... 1

Huntleigh Technology plc ...................... .......................... ......................... 3

Chapter 2: Financial Analysis ................................................................................................................................... 6

Profitability .......................... ........................... ......................... ................. 7

Efficiency ...................... ............................ ......................... ..................... 8

Liquidity ......................... ............................ ......................... ..................... 10

Gearing Ratios........................................... ......................... ..................... 12

Investment Ratios ........................ ........................... ......................... ........ 12

Chapter 3:Evaluation of recommended investment ............................................................................................. 15

Table 3.1: Scenario1 - Investment of 20 million in Smith & Nephew plc. 16

Table 3.2: Scenario 2 Investment of 10 million in Smith & Nephew plc and 10 million in HuntleighTechnology plc. ...................... ........................... .......................... ............................ ......................... ................ 17

Table 3.3: Scenario 3 - Investment of 20 million in Huntleigh Technology plc. ........................... .................... 18

Table 3.4: Effect of factor on the return on investment after three years 19

Table 3.5: Effect of estimated dividend on the return on investment after three years 19

Chapter 4: Discussion ............................................................................................................................................... 15

Table 4.1: SWOT analysis for Smith & Nephew plc ....................... ......................... ............................ ............... 21

Table 4.2: SWOT analysis for Huntleigh Technology Plc ........................ .. 25

Chapter 5: Conclusions ............................................................................................................................................. 28

Appendix A: .............................................................................................

Appendix B: .............................................................................................

References ..............................................................................................


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ChapterIntroduction

1

An independent research was carried out in two healthcare companies, Smith & Nephew Plc and

Huntleigh Technology Plc. because of good prospect of companies in the healthcare sector. The

ageing population, combined with more active lifestyles and increased affluence, has created

significant demand for more effective healthcare products. Furthermore pressure to resist increases

in overall healthcare spending has led healthcare providers to demand products which minimise the

length of hospital stays and surgeon and nursing resources.

Smith & Nephew plcSmith & Nephew Group is an

international medical devices business

engaged in orthopaedics, endoscopy and

advanced wound management having

annual sales of 1.2 billion. Smith &

Nephew is an English public limited

company and was incorporated and

listed on the London Stock Exchange in

1937 and on the New York Stock

Exchange in 1999. In 2001, Smith &

Nephew became a constituent part of the

FTSE-100 index in the UK and has been

included in the Dow Jones Sustainability Index (DJSI), the most widely recognised arbiter of good

practice, and in the list of FTSE4Good companies. Smith & Nephew is committed to the protection of

the environment by using renewable resources, wherever possible, and developing manufacturing

processes and products that minimise adverse effects on the environment. In 2003, direct donations

to charitable and community activities totalled 937,000

The orthopaedics, arthroscopy and wound management market share represent 45%, 25% and 30%

of sales of Smith & Nephews ongoing operations. The Groups expenditures on research and

development amounted represents approximately 6% of group turnover. Smith & Nephews turnover

and profit margin before interest and tax were 1.18 billion and 20.77%, respectively. The total

number of full-time employees was 7,451, with an average remuneration of 41,400. Smith &

Smith & Nephew Profile

-1

9

19

29

39

Average 1995 1997 1999 2001 2003Years

Ratios

EBIT Margin (%)-S&N Turnover-S&N/100,000()

Av. Remun. per Emp/1000 No. of employees/1000

Fig. 1.1: Company profile - Smith & Nephew PLC


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Nephews profile over the last ten years is illustrated in Fig. 1.1. The company turnover has been

increasing consistently from 0.965 billion in 1994 to 1.135 billion in 2003. Following a loss in 1994,

its level of earning before interest and tax has sharply risen to above 13.7% from 1995 onwards

despite the reduction in number of employees since 1998. Smith & Nephew plcs five year total

shareholder return was 170% by the end of 2003, compared with -10% with the FTSE 100. Smith &

Nephews accounting records and supporting documents are designed to accurately describe and

reflect the nature of underlying transactions and conform to UK GAAP.

The Group business policies aim to achieve long-term growth and profits which in turn bring

continued economic benefits to shareholders, employees, suppliers and local communities. Smith &

Nephew operates on a worldwide basis through a series of investments and acquisitions,

predominantly in the US but also in Europe, and through continued emphasis on the development andintroduction of new products to the Groups principal markets. In order to maintain its market

leadership position, Smith & Nephew plc has acquired at least six companies from January 2002

onwards, namely (a) ORATEC in 2002, (b) the remaining 50% of Advanced Tissue Sciences, Inc.

Fig. 1.2: Smith & Nephew plcs five year shareholder return.

Source, Smith & Nephew plc annual report, 2003


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(ATS) in November 2002, (c) Midland Medical Technologies (MMT) in September 2003, (d)

VERSAJET from HydroCision Inc. in January 2004, (e) Reed Medical Designs, Inc., in February 2004

and (f) Corin plc in April 2004. Smith & Nephew plc has also disposed of companies that were not

profitable, such as 21.5% equity interest in AbilityOne in 2003, the ear nose and throat business in

2001 and the rehabilitation business in 2002.

Smith & Nephews products conform to the complex series of laws and regulations that are

administered and enforced by national authorities and that govern the testing, approval,

manufacturing, labelling, marketing and sale of healthcare and pharmaceutical products. Smith &

Nephew believes that the Groups operations currently comply in all material respects with applicable

environmental laws and regulations and that these recent changes will not have a material adverse

effect on the Groups financial condition and the results of operations. The Group carries product

liability insurance to cover exposure as far as practicable and believes that there are currently no

individual product liability claims that are expected to have a material adverse effect on the Groups

financial position or results of operations. The Group maintains liability provisions to cover known

uninsured risks.

Huntleigh Technology plcHuntleigh Technology plc is involved in the design, manufacture, distribution and rental of medical

equipment world-wide, with representation in over 120 countries and a highly trained team of over

700 sales and service personnel. Rental sales is continuing to replace outright capital sales,

especially outside the United Kingdom, growing by 17% to 42.5 million and now representing 24.5%

of Group manufactured product. From their locations in the United Kingdom and abroad, the principal

product divisions design and manufacture an extensive range of non-invasive healthcare devices andinstrumentation for use in a wide spectrum of medical applications. Over the past 30 years Huntleigh

has built up a market leading position in:

Patient Positioning and Transportation (PPT),

Pressure Area Care (PAC) for the prevention and treatment of pressure ulcers,

Intermittent Pneumatic Compression (IPC) for the prevention of deep vein thrombosis,

Ultrasonic Diagnostics.

Huntleigh Technology plcs financial situation in 2003 is summarised below:

y EPS up 4% to 18.2py Interest cover up 2% to 20.9 times

y Dividend cover down 1% to 3.0 times

y Borrowings down 5% to 17.6m

y Total dividend up 5% to 6.0p


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y Profit before tax rose by 7% or 1.4 million to 23.1 million.

y Gross margin increased by 1.5% to 54.5%.

y Distribution costs and administrative expenses increased 10% to 77.7 million.

y Net current assets increased by 21% and net assets employed by 16%.

y

There were no significant investments during 2003.Much focus has also been given to the environmental impacts of our products and processes such as

wasteminimisation, energy management and

transport and distribution practices.

Despite a disappointing first half of 2002,

y Sales went up 6% to 187.2m

y Pretax profit went up 7% to 23.1m

y Net assets went up 16% to 79.5m

y Gearing went down 5% to 22%

y Final dividend went up 6% to 3.3p

Huntleigh Technology plcs turnover and profit

margin before interest and tax were 187.2

million and 13.33%, respectively. The total

number of full-time employees was 2,330, with an average remuneration of 26,193. Huntleigh

Technology plcs profile over the last ten years is illustrated in Fig. 1.3. The company turnover has

been increasing consistently from 12.23 million in 1994 to 187.2 million in 2003. From 1995

onwards, Huntleigh Technology plcs level of earning before interest and tax has been 12.5 % or

above from.

The turnover by location is summarised in Table 1.1 and by product in Table 1.2

Huntleigh Technology Profile

0

5

10

15

20

25

Average 1995 1997 1999 2001 2003Years

Ratios

EBIT Margin (%)-HTL Turnover-HTL/10,000()

Av. Remun. per Emp/1000 No. of Employees/100-HTL

Fig. 1.3: Company profile - Huntleigh Technology plc

Regions Turnover (m)

/ Change (%)

UK 79.4 / +5%

Europe 43.5 / +16%

US 42.3 / -1%Rest of the world 22.0 / +7%

Table 1.1: Turnover by region

Medical applications Turnover (m)

/ Change (%)

% of group

turnover

Patient Positioning and

Transportation

61 / +4% 32

Pressure Area Care 71 / +6% 38Intermittent pneumatic 37 / +13% 20

Table 1.2: Turnover by product


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Huntleigh Technology plcs five year total shareholder return compared with the FTSE SmallCap is

shown in Figure 1.4 and share price, compared with Smith & Nephews over the last 10 years is

shown in Fig. 1.5. These graphs show that Huntleigh Technology plc has a lower gearing than and

rate of return to share holders than Smith & Nephew plc. Huntleigh Technology plcs accounting

records and supporting documents are designed to accurately describe and reflect the nature of

underlying transactions and conform to UK GAAP.

Fig. 1.4: Huntleigh Technology plcs five year share holders returnSource: Huntleigh Technology plc annual report, 2003.


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Share Price Trends

0

100

200

300

400

500

600

700

04/01

/1994

04/01

/1995

04/01

/1996

04/01

/1997

04/01

/1998

04/01

/1999

04/01

/2000

04/01

/2001

04/01

/2002

04/01

/2003

04/01

/2004

Year

Share(p)

Smith & Nephew Huntleigh Technology

Fig. 1.5: History of share prices for Huntleigh Technology plc and Smith & Nephew plc since 1994

Source: Yahoo Finance website


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ChapterFinancial Analysis

2

We have analysed and compared the key financial ratios for Smith & Nephew plc and Huntleigh

Technology plc over the last ten years to detect whether there has been an improvement or

deterioration in performance (Gasking, 1993; Atrill, 2003; FAME website). Figs. 2-2.9. show the

financial ratios for profitability, efficiency, liquidity, gearing and investment (FAME website), which are

important for decision-making purposes (Atrill, 1993).

Profitability

The return on ordinary shareholders funds (ROSF), return on capital employed (ROCE) (Fig. 2.1),net profit margin and gross profit margin (Fig. 2.2) were used to evaluate the profitability of the two

businesses. Apart from the poor performance of Smith & Nephew plc in 1994, which could be due to

high investment, poor economy or high interest rates, the ROCE graphs show a high rate of

profitability with relation to long-term capital invested in both Smith & Nephew plc and Huntleigh

Technology plc over the last ten years, with an average of 28% and 32.4%, respectively. The ROCE

trend for Huntleigh Technology plc has been decreasing over the years and that for Smith & Nephew

plc has been fluctuating. The ROSF graphs, which follow the same trend as the ROCE graphs, show

a healthy amount of profit available to the shareholders with the ordinary shareholders stake in both

companies (37.5% for Smith & Nephew Plc. and 43.2% for Huntleigh Technology plc.). Apart from

Smith & Nephew plc in 1994, both companies have maintained a consistently healthy percentage

ROCE and ROSF, which is much more than the kind of return it would get if the money were invested

in a building society or a bank. The slightly decreasing trends of these ratios for Huntleigh

Technology plc do not seem to be a danger.

Both Smith & Nephew plc and Huntleigh Technology plc have maintained consistently high gross

profit margin of over 50% and net profit margin of over 10% over the last 10 years. Smith & Nephew

plc, whose sales turnover is 10 times higher than that of Huntleigh Technology plc, has higher and

increasing trends for net profit (EBIT) margin and gross profit margin. The similarity of the ROCE and

net profit margin curves for Smith & Nephew plc and Huntleigh Technology plc show the influence ofnet profit margin for the two companies on the companies performances. Unlike Huntleigh

Technology plc, whose profit margins trends are more or less constant over time, Smith & Nephew

plc trends on profit margins often reveal an increase in gross profit margin accompanied by a

decrease in net profit margin, for example in 1996, 2001 and 2002. This is because operating

expenses for Smith & Nephew plc could have been absorbing a greater proportion of sales income.


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Smith & Nephew plc has been using some of the profit to invest in the company or purchase rival

companies. This explains its rapidly increasing sales turnover.

EfficiencyThe average stock turnover period, average settlement periods for debtors and creditors, sales to

capital employed and sales per employee were used to evaluate the efficiency of the two businesses.

Huntleigh Technology plc has a much lower

stock turnover (average of 107 days over the

last ten years and remaining more or less

constant over the years) than Smith & Nephew

plc (average of 202 days and increasing overthe years) (Fig. 2.3). These figures indicate

that Smith & Nephew plcs funds are tied up in

stocks whereas Huntleigh Technology plcs

funds can be used for more profitable

purposes. The higher and still increasing stock

turnover for Huntleigh Technology plc (average

of 7.8 over the past 10 years) compared to that

of Smith & Nephew plc (average of 4.8 over the last 10 years) (Fig. 2.3) shows that Huntleigh

Technology plc is likely to make a much higher return in the investment made in inventory.

Smith & Nephew plcs customers take, on average over the last 10 years, 79 days to pay the amount

owing and this has been gradually decreasing slightly over the years in general to 76 days in 2003.

Efficiency

0

5

10

15

20

25

Average 1996 1999 2002Years

Ra

tios

Stock Turnover-HTL Stock Turnover-S&N

Sales to cap ital employed-HTL Sales to cap ital employed-S&N

Sales per employee(10,000)-HTL Sales per employee(10,000)-S&N

Stock turnover per iod / 10-HTL Stock turnover per iod / 10-S&N

Fig. 2.3: Efficiency of Huntleigh Technology PLC and

Smith & Nephew PLC

Fig. 2.1: ROSF and ROCE trends for Huntleigh

Technology PLC and Smith & Nephew PLC

Financial performance

-10

10

30

50

70


Ratios

ROCE (%)-HTL ROCE (%)-S&N

ROSF (%)-HTL ROSF (%)-S&N

Profitability

0

5

10

15

20

25


Ratios

Gross Margin/10 (%)-HTL Gross Margin/10 (%)-S&NEBIT M argin (%)-HTL EBIT M argin (%)-S&NTurnover-HTL/10,000() Turnover-S&N/100,000()

Fig. 2.2: Gross and net profit margin trends for

Huntleigh Technology PLC and Smith & Nephew PLC


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Smith & Nephew plc is gradually reducing its cash that is tied up in its customers hands. Huntleigh

Technology plcs customers take an average of 75 days over the last 10 years to pay the amount

owing and this has been increasing rapidly over the years (Fig. 2.4) to 95.3 days in 2003. The

Huntleigh Technology plc would therefore need increasing amount of cash to finance the negative

effect of the debtor days on its cash flow, especially with increasing trade.

Smith & Nephew plc takes an average of 42

days over the last 10 years to pay its trade

creditors and, with almost no overall change in

trend over the years, its average settlement

period was 41 days in 2003. Smith & Nephew

plc is therefore paying its suppliers before

receiving payment from its customers. This

could have a negative effect on its cash flow.

Huntleigh Technology plc has an averagesettlement period for creditors of 33 days and,

with a decreasing trend over the years, took an

average of 26 days to settle accounts with its

creditors (Fig. 2.4). With an increasing debtor

days and decreasing creditor days, Huntleigh Technology plc could face cash flow problems because

it is paying its suppliers over three times faster than it is receiving money from its customers.

Huntleigh Technology plc may be paying creditors promptly in order to maintain goodwill or to take

advantage of discounts.

The average sales to capital ratio over the last 10 years is 1.8 for Smith & Nephew plc and 2.3 for

Huntleigh Technology plc, respectively. With the slight decreasing trends for both companies, this

figure has reached 1.4 for Smith & Nephew plc and 1.8 for Huntleigh Technology plc in 2003 (Fig.

2.3). These figures show that Huntleigh Technology plc is more effective at generating sales revenue

from long-term capital employed than Smith & Nephew plc, but the decreasing trends suggest that

both companies are using their capitals less and less productively with time. Either they are tying up

proportionally more and more working capital than they are getting in sales improvement or their

sales are falling away without the accompanying reduction in the investment in capital employed. The

fluctuating and more or less constant ROCE for Smith & Nephew plc, despite the decreasing sales to

capital employed ratio, is compensated for by the increasing net profit margin.

With an average sales per employee ratio of 102,000 over the last 10 years and increasing trend to

158,000 in 2003, Smith & Nephew plc has a high workforce productivity. The average sales per

employee ratio over the last 10 years for Huntleigh Technology plc is rather low, at 79,000. With the

slightly increasing trend this figure rose to 80,000 in 2003 so the workforce profitability for Smith &

Cash Elasticity of Current Assets

20

30

40

50

60

70

80

90

100


Ratios

Creditors Payment -HTL(days) Creditors Payment-S&N(days)Debtor Col lection (days) -HTL Debtor Col lect ion-S&N(days)

Fig. 2.4: Cash elasticity for Huntleigh Technology

PLC and Smith & Nephew PLC


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Nephew plc was almost twice the working profitability for Huntleigh Technology plc in 2003. A

decreasing sales to capital ratio, accompanied by an increasing sales per employee ratio for Smith &

Nephew plc could be the result of the acquisition of several medical product companies in the last

few years.

The trends in fixed asset assets turnover in

Fig. 5 indicate that there has been an overall

reduction in the amount of activities Smith &

Nephew plc and Huntleigh Technology plc are

deriving from their investments in fixed and net

assets over the last ten years. With an average

assets turnover of 4.07 over the last decade

and 3.58 in 2003, Huntleigh Technology plc

seems to be deriving higher profit to its

investment than Smith & Nephew plc, whoseaverage assets turnover was 2.89 over the last

decade and 1.8 in 2003. Smith & Nephew plc

has been enjoying an increasing working capital ratio of up to 0.427 in 2001, which rapidly decreased

to 0.342 in 2001, while HuntleighTechnology plcs working capital ratio decreased to 0.269 in 2001

but increased rapidly to 0.333 in 2003 (Fig. 5). These figures indicate that Huntleigh Technology plc

had been tying up proportionally more in working capital then it was getting in sales in improvement

until 2001, after which it started to enjoy greater sales and profit, without having to provide the

proportional amount of investment in working capital. The reverse is true for Smith & Nephew plc.

LiquidityWith an average current ratio of 1.5 over the

last ten years and a constantly increasing

trend to 2.0 in 2003 (Fig. 2.6), Huntleigh

Technology plc has increasing current

assets to cover the current liabilities by two

fold, although it has been having relatively

and consistently fast moving stocks (99 days

in 2003 Fig. 2.4). Therefore, Huntleigh

Technology plc has a comfortable amount of

liquidity that can be made available to cover

any short-term calling in of money by

suppliers, banks or share holders. However,

Liquidity

0.3

0.8

1.3

1.8

Average 1995 1997 1999 2001 2003Years

Ratios

Current Ratio-HTL Current Ratio-S&NAcid Test Ratio-HTL Acid Test Ratio-S&NOp CF to MO ratio-HTL Op CF to MO ratio-S&N

Fig. 2.6: Liquidity ratios for Huntleigh Technology PLC

and Smith & Nephew PLC

Assets Turnover

1.3

2.8

4.3

Average 1995 1997 1999 2001 2003Years

Ratios

Net Assets Turnover-S&N Net Assets Turnover-HTL

Fixed Assets Turnover-S&N Fixed Assets Turnover-HTL

Working Cap Turnover X 10-S&N Working Cap Turnover x 10-HTL

Fig. 2.5: Assets turnover for Huntleigh Technology PLC



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the company is also tying up an increasing amount of cash in the liquid assets in the working capital.

Smith & Nephew plc has been having decreasing current assets to cover its current liabilities during

the last decade until 2002 (its current ratio has been decreasing from 1.77 in 1994 to 1.15 in 2003)

but increased sharply in 2003 to 1.46, as illustrated by its current ratio in Fig. 2.6. This trend does not

reflect that of its stock and stock turnover period (Fig. 2.4) for example, as the stock turnover period

decreases from 2002 to 2003, Smith & Nephew plcs current ratio increases. This indicates that

Smith & Nephew plcs current ratio does not seem to be influenced by the amount of cash tied in

stock but is more influenced by its current liabilities, based on figures from its balance sheet in

Appendix A.

The acid test ratios, which excludes stock in the current assets, for both companies are similar in

trend to the current ratios. Huntleigh Technology plc has an increasing acid test ratio trend from 0.82

in 1994 to 1.52 in 2003, indicating that the company is unlikely to be faced with liquidity problem but

is tying up an increasing amount of cash, which could be used more profitably, in the liquid assets.

Smith & Nephew plc has an average acid test ratio of 0.88 over the last 10 years and 0.89 in 2003. Ifthis ratio does not increase above 1, Smith & Nephew plc could be faced with liquidity problems.

Since both the current ratio and the acid test ratios are derived from the balance sheet, which is a

snapshot of the financial position of the two companies at 31/12 of each year, the operating cash

flows to maturing obligations ratios are analysed to obtain a more reliable guide to the liquidity of the

companies. Both Smith & Nephew plc and Huntleigh Technology plc have a very low average value

of operating cash flows to maturing obligations ratio of 0.50 over the past ten years. Huntleigh

Technology plcs operating cash flows to maturing obligations ratio has been increasing consistenly

over the 10 years to 0.62 in 2003, while Smith & Nephew plcs operating cash flows to maturing

obligations ratio has remained more or less stagnant and was 0.53 in 2003 (Fig. 6). Huntleigh

Technology plcs operating cash flows to maturing obligations ratio does not reflect its acid test ratio

and this could be because its balance sheet on the 31st of December is not representative of the

liquidity position during the year. The operating cash flows to maturing obligations ratio ratios for both

companies are quite low and reveal that the cash flows over the 10 years have not been covering

maturing obligations. But they have both survived and prospered during this time.

Smith & Nephew believes that its capital expenditure needs and its working capital funding for 2004,

as well as its other known or expected commitments or liabilities, can be met from its existing

resources and facilities.


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Gearing RatiosThe average gearing ratios for Huntleigh

Technology plc and Smith & Nephew plc over

the last 10 years are 73.16% and 51.2 %,

respectively. Huntleigh Technology plc has

been decreasing its gearing ratio from a

dangerous 123.7 % in 1994 to a secure 43%

in 2003 while Smith & Nephew plcs gearing

ratio rose suddenly to 96.2% in 2000 and

rapidly decreased to a comfortable 46.6% in

2003 (Fig. 2.7). Translation of foreign

currency net debt into sterling had the effect

of decreasing Smith & Nephew plcs net debt

by 108.1m in the three-year period ended 31 December 2003. Both companies had a high level of

gearing at some point due to heavy borrowing from outside parties, thereby increasing the risk ofbeing insolvent due to increased commitment on paying interest charges. However, both companies

managed to reduce their gearing ratios because a substantial part of the long-term loan was repaid.

Smith & Nephew plc and Huntleigh Technology plc were comfortable about taking such high levels of

gearing because they have growing cash flows and profits.

Huntleigh Technology plc and Smith & Nephew plc have been having comfortable interest cover

ratios over the past ten years, with average values of 20.6 and 15.5, respectively, that is, their levels

of profits are higher than the levels of interest payable. The trends of the interest cover ratios have

been more or less constant for both companies, with Smith & Nephew plcs interest cover ratio

varying between 11.19 and 23.9 (except from 0.49 in 1994) and Huntleigh Technology plcs interest

cover ratio varying between 13.48 and 31.56. Huntleigh Technology plc has a history of having a

higher level of profit to cover interest.

Investment RatiosThe earning per share, price earning,

dividend cover, dividend yield and dividend

per ordinary share are analysed to assess

the returns on investment for Smith &

Nephew plc and Huntleigh Technology plc.

Bearing in mind that some of the companies

earnings are ploughed back to achieve

Inves tment Ratios

0.00

2.00

4.00

6.00

1999 2000 2001 2002 2003Years

Ratios

Div per o rd share(p)-HTL D iv id per o rd share(p)-S&N

Div idend cover rat io -HTL D iv idend cover rat io -S&N

Dividend yield rat io(%)-HTL Dividend Yield(%)-S&N

Fig. 2.8: Dividend cover, dividend yield and dividend

per share ratios for Huntleigh Technology PLC and

Smith & Nephew PLC

Gearing

0

50

100

Average 1995 1997 1999 2001 2003Years

Ratios

Gearing (%)-HTL Gearing (%)-S&N

Interes t Cover-HTL Interes t Cover-S&N

Fig. 2.7: Gearing ratios for Huntleigh Technology PLC



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future growth, the dividend per share ratio for Huntleigh Technology plc has been increasing

consistently from 4.0 in 1999 to 6.0 in 2003, whereas that for Smith & Nephew plc decreased sharply

from 6.5 to 4.5 in 2000 and gradually increased to 4.95 in 2003 (Fig. 2.8). This indicates that

Huntleigh Technology plcs shareholders could be receiving more cash return from holding shares

than Smith & Nephew plcs share holders in the short term. However, Smith & Nephew plc is growing

at a faster rate due to money being ploughed back into the business for growth. This is very likely to

increase the share price even more, as per Fig. 1.5, and dividend in the future. Following the capital

restructuring and dividend reduction in 2000 Smith & Nephew plc adopted a policy of increasing its

dividend cover. This was intended to increase the financing capability of the Group for acquisitions

and other investments. Over the last three years the dividend has been increased in line with

inflation. Dividend cover (the ratio of attributable earnings before goodwill amortisation and

exceptional items, as set out in the Five Year Record, to ordinary dividends) has increased from 3.0

times in 2001 to 3.7 times in 2003.

There has been a slight decrease in dividend

cover ratio for Huntleigh Technology plc from

3.22 in 1999 to 3.03 in 2003, while that for

Smith & Nephew plc has been fluctuating

between 1.45 and 4.97 from 1999 to 2003 (Fig.

2.9). The amount by which the earnings

available for dividend to cover the amount

announced by Huntleigh Technology plc has

been decreasing slightly over the five years

from 3.22 to 3.03, whereas that for Smith &Nephew plc has been fluctuating over the five

years and reached 3.21 in 2003. The trends in

dividend yield ratio in Fig. 2.8 shows that the cash return from a share to its current market value has

been increasing constantly from 1.44% in 1999 to 2.29% in 2003 for Huntleigh Technology plc and

has been decreasing from 3.45% in 1999 to 1.25% in 2003 for Smith & Nephew plc. Dividend yield

for both companies remain fairly low, indicting that both companies are ploughing money back into

the business for future growth. The recent investments on acquisition of new assets by Smith &

Nephew plc in the last three years are likely to result in an increase in dividend in the coming years,

despite its policy of increasing its dividend cover, due to anticipated financial return on the Groups

growth.

The earning per share for Huntleigh Technology plc has been increasing consistently from 13.98p in

1999 to 18.20p in 2003, indicating a good share performance and investment potential of shares in

Huntleigh Technology plc. The earning per share ratio for Smith & Nephew plc follows the same trend

Inves tment Ratios

9.00

14.00

19.00

24.00

29.00

1999 2000 2001 2002 2003Years

Ratios

EPS(p)-HTL EPS(p)-S&N

P /E ratio-HTL P /E ratio -S&N

Fig. 2.9: Earning per share and Price earning ratios forHuntleigh Technology PLC and Smith & Nephew PLC


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as its dividend cover ratio, fluctuating between 9.39p and 20.07p, ending at 15.92p in 2003 (Fig. 2.9).

This indicates a fluctuating but upward trend in share performance for Smith & Nephew plc.

The market confidence in both Smith & Nephew plc and Huntleigh Technology plc seem to have

increased until 2002 and decreased sharply in 2003, based on the trend of the price to earning ratio.

The capital values of the shares for Huntleigh Technology plc and Smith & Nephew plc in 2003 are

14.4 and 24.9 times respectively higher than their current levels of earnings. These figures have

come down from 20.29 times and 31.06 times, respectively in the previous year, indicating a

decrease in investors confidence that future profits are going to be higher than past or that the

shares are going to be worth more in future.


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ChapterEvaluation of

recommended investment3

Both Huntleigh Technology plc and Smith & Nephew plc have been outperforming the FTSE100

during the last decade and enjoyed good rate of returns. Smith & Nephew plcs policy has been to re-

invest profit into the group for improved growth, thereby increasing the dividend cover ratio. As a

result Smith & Nephew plcs share value has been increasing sharply over the last 5 years,

compared with Huntleigh Technology plc, where the dividend cover ratio has remained stagnant and

decreased slightly over the last few years. Moreover, Smith & Nephew plc has bought about 6

medical product companies over the last 2 years, which is likely to boost its level of return. Following

some evaluations and feasibility studies of investing different proportions of the 20 million in the twoproposed groups, we propose to invest all the 20 million in Smith & Nephew plc, following results

based on Tables 3.1, 3.2 and 3.3. Table 3.3 shows that even a 50% reduction in dividend will still

result in a comfortable return on investment after 3 years.

The required rate of return for investors for a particular share, RO, can be calculated from:

RO = RRF+ (RM RRF), where:

RRF= The risk-free rate on government securities (3.5%)

RM = The diversified market rate of return

= Risk element, equity beta for worst case scenario.(Samuels et al., 2003)

KO = 3.5 + 1.8(9.96-3.5) = 15.13%

Table 3.1 gives the best rate of return on investment. Smith & Nephew plc has a higher value (0.86)

than Huntleigh Technology plc (0.6) (http://uk.biz.yahoo.com/tech/h/htl.l.html), hence, a higher risk

factor. Smith & Nephew plcs rate of return is much higher than that of Huntleigh Technology plc.

Since its value is lower than 1, it does not present a high investment risk.


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Table 3.1: Scenario1 - Investment of 20 million in Smith & Nephew plc.Beta factor 1.80

CAPM=r 15.13 3.50

y-4 y-3 y-2 y-1 y0 y1 y2 y3

Dividends per share-HTL (p) 4.00 4.40 5.20 5.70 6.00

Dividends per share-S&N (p) 6.50 4.50 4.65 4.80 4.95

Rate of dividend growth-HTL (%) 10.00 18.18 9.62 5.26Rate of dividend growth-S&N (%) -30.77 3.33 3.23 3.13

Estimated rate of dividend growth-HTL (%) 4.40 3.80 3.40Estimated rate of dividend growth-S&N (%) 3.03 2.95 2.88 2.85Estimated dividends per share-HTL (p) 6.00 6.26 6.50 6.72 6.72Estimated dividends per share-S&N (p) 4.95 5.10 5.25 5.40 5.56Estimated rate of share priceincrease-HTL (%/year) 0.20Estimated rate of share priceincrease-S&N (%/year) 0.40

Profit after taxation-HTL(m) 10.86 12.17 14.31 14.85 15.46

Dividends-HTL (m) 5.10 4.84 4.41 3.73 3.38

Proportion of profit retained-HTL-(%) 53.08 60.23 69.15 74.90 78.15

Estimated proportion of profitretained-HTL(%) 81.00 82.00 82.50 82.8

Profit after taxation-S&N(m) 104.80 207.50 129.60 112.10 148.10

Dividends-S&N (m) 32.30 -289.40 86.70 67.50 102.00Proportion of profit retained-S&N-(%) 224.46 -171.70 49.48 66.07 45.20Estimated proportion of profitretained-S&N(%) 60.00 70.00 80.00 90

Growth rate-HTL (%)=rb 8.03 9.11 10.46 11.33 11.82 12.25 12.40 12.48 12.53

Growth rate-S&N (%)=rb 33.96 -25.97 7.49 10.00 6.84 9.08 10.59 12.10 13.62

Est Share Price-HTL () 3.60 4.32 5.18 6.22 7.46

Est Shareprice-S&N () 4.80 6.72 9.41 13.17 18.44

Dividend-HTL (million) 0.00 0.00 0.00 0.00Investment (million)-HTL 0.00 0.00 0.00 0.00

npv-HTL 0.00 0.00 0.00 0.00 0.00

Dividend-S&N (million) 1.55 1.35 1.17 1.02

Investment (million)-S&N 27.98 32.89 43.48 76.64

NPV-S&N -20.00 24.33 28.60 37.81 66.64

No. of shares (million)-HTL 0.00 0.00 0.00 0.00

Investment (million)-S&N -20.00

No. of shares (million)-S&N 1.49 1.06 0.76 0.54

Sub total -20.00 1.55 1.35 1.17 1.02

Sell shares after 3 years 29.63

Discount rate of 15.13 1.00 0.87 0.75 0.66 0.57

dcf -16.86 -20.00 1.35 1.02 0.77 0.58

0.00 -20.00 1.35 1.02 0.77 16.86Feasibility -

S&N return after 1-2-3 years 32.886 43.482 76.641HTL return after 1-2-3 years (m) 0.00 0.00 0.00

Total return after 1-23 years (m) 32.89 43.48 76.64


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Shares must be sold for 29.63million after 3 years to achieve a rate of return of 15.13%. Value of

shares after 3 years, using P3=D3(1+g)/(r-g), where P3 is the share price after 3 years, D3 is the

dividend after 3 years, g is the growth and r is the expected rate of return, is 76.64 million.

Table 3.2: Scenario 2 Investment of 10 million in Smith & Nephew plc and 10 million in

Huntleigh Technology plc.Beta factor 1.80CAPM=r 15.13 3.50

y-4 y-3 y-2 y-1 y0 y1 y2 y3



Rate of dividend growth-HTL (%) 10.00 18.18 9.62 5.26

Rate of dividend growth-S&N (%) -30.77 3.33 3.23 3.13

Estimated rate of dividend growth-HTL (%) 4.40 3.80 3.40

Estimated rate of dividend growth-S&N (%) 3.03 2.95 2.88 2.8

Estimated dividends per share-HTL (p) 6.00 6.26 6.50 6.72 6.7

Estimated dividends per share-S&N (p) 4.95 5.10 5.25 5.40 5.5Estimated rate of share price increase-HTL(%/year) 0.20

Estimated rate of share price increase-S&N(%/year) 0.40


Dividends-HTL (m) 5.10 4.84 4.41 3.73 3.38

Proportion of profit retained-HTL-(%) 53.08 60.23 69.15 74.90 78.15Estimated proportion of profit retained-HTL(%) 81.00 82.00 82.50 82


Dividends-S&N (m) 32.30 -289.40 86.70 67.50 102.00

Proportion of profit retained-S&N-(%) 224.46 -171.70 49.48 66.07 45.20Estimated proportion of profit retained-S&N(%) 60.00 70.00 80.00 9

Growth rate-HTL (%)=rb 8.03 9.11 10.46 11.33 11.82 12.25 12.40 12.48 12.5

Growth rate-S&N (%)=rb 33.96 -25.97 7.49 10.00 6.84 9.08 10.59 12.10 13.6



Dividend-HTL (million) 0.30 0.26 0.22 0.1

Investment (million)-HTL 11.54 10.61 9.50 8.4

npv-HTL -10.00 10.04 9.23 8.26 7.3



NPV-S&N -10.00 12.16 14.30 18.91 33.3


Investment (million)-S&N -10.00

No. of shares (million)-S&N 1.49 1.06 0.76 0.5

Sub total -20.00 1.07 0.93 0.81 0.7


Discount rate of 15.13 1.00 0.87 0.75 0.66 0.5

dcf -17.84 -20.00 0.93 0.70 0.53 0.4

Feasibility -

S&N return after 1-2- 3 years 16.443 21.741 38.21

HTL return after1-2-3 years (m) 10.61 9.5 8.41

Total return after 1-2-3 years (m) 27.05 31.24 46.73


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Shares must be sold for 31.33 million after 3 years to achieve a rate of return of 15.13%. Value of

shares after 3 years, using P3=D3(1+g)/(r-g), where P3 is the share price after 3 years, D3 is the

dividend after 3 years, g is the growth and r is the expected rate of return, is 43.57 million.

Table 3.3: Scenario 3 - Investment of 20 million in Huntleigh Technology plc.Beta factor 1.80

CAPM=r 15.13 3.50

y-4 y-3 y-2 y-1 y0 y1 y2 y3



Rate of dividend growth-HTL (%) 10.00 18.18 9.62 5.26

Rate of dividend growth-S&N (%) -30.77 3.33 3.23 3.13Estimated rate of dividend growth-HTL (%) 4.40 3.80 3.40Estimated rate of dividend growth-S&N (%) 3.03 2.95 2.88 2.85

Estimated dividends per share-HTL(p) 6.00 6.26 6.50 6.72 6.72Estimated dividends per share-S&N(p) 4.95 5.10 5.25 5.40 5.56

Estimated rate of share priceincrease-HTL (%/year) 0.20Estimated rate of share priceincrease-S&N (%/year) 0.40


Dividends-HTL (m) 5.10 4.84 4.41 3.73 3.38

Proportion of profit retained-HTL-(%) 53.08 60.23 69.15 74.90 78.15

Estimated proportion of profitretained-HTL(%) 81.00 82.00 82.50 82.8


Dividends-S&N (m) 32.30-

289.40 86.70 67.50 102.00

Proportion of profit retained-S&N-(%) 224.46

-171.70 49.48 66.07 45.20

Estimated proportion of profit

retained-S&N(%) 60.00 70.00 80.00 90Growth rate-HTL (%)=rb 8.03 9.11 10.46 11.33 11.82 12.25 12.40 12.48 12.53

Growth rate-S&N (%)=rb 33.96 -25.97 7.49 10.00 6.84 9.08 10.59 12.10 13.62



Dividend-HTL (million) 0.59 0.51 0.45 0.39

Investment (million)-HTL 23.09 21.22 18.99 16.81

npv-HTL -20.00 20.08 18.45 16.52 14.62



NPV-S&N 0.00 0.00 0.00 0.00 0.00


Investment (million)-S&N 0.00

No. of shares (million)-S&N 1.49 1.06 0.76 0.54Sub total -20.00 0.59 0.51 0.45 0.39


Discount rate of 15.13 1.00 0.87 0.75 0.66 0.57

dcf -18.81 -20.00 0.51 0.39 0.29 0.22


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0.00 -20.00 0.51 0.39 0.29 18.81

Feasibility -

S&N return after 1-2-3 years 0 0 0HTL return after 1-2-3 years (m) 21.22 18.99 16.81

Total return after 1-2-3 years (m) 21.22 18.99 16.81

Shares must be sold for 33.04 million after 3 years to achieve a rate of return of 15.13%. Value of

shares after 3 years, using P3=D3(1+g)/(r-g), where P3 is the share price after 3 years, D3 is thedividend after 3 years, g is the growth and r is the expected rate of return, is 16.81 million.

A sensitivity analysis was carried out on the beta factor between 1.2 and 1.8. It was found that, even

when was reduced to a minimum of 1.2, this would not a significant effect on the value of the

shares after 3 years, as shown in Table 3.4.

Table 3.4: Effect of factor on the return on investment after three years factor Sale of shares after 3 years to achieve

expected rate of return (m)

Value of shares after 3

years (m)

1.8

20m in S&N

10m S&N, 10m in HTL

20m in HTL

29.63

31.33

33.03

76.64

46.73

16.81

1.2

20m in S&N

10m S&N, 10m in HTL

20m in HTL

26.77

27.96

29.25

75.53

46.16

16.79

A

sensitivity analysis was carried out on a 50% increased or decreased projected dividend for the twocompanies. Table 3.5 shows that, should the actual dividends be more than the predicted ones, the

shares would be worth over four times more than with the predicted dividend. Even if the dividend is

reduced by 50%, a reasonable rate of return is expected if the 20 million is invested in Smith &

Nephew plc.

Table 3.5: Effect of estimated dividend on the return on investment after three yearsChange in estimated

dividend

Sale of shares after 3 years to

achieve expected rate of return (m)

Value of shares after 3 years

(m)

+50%

20m in S&N

10m S&N, 10m in HTL

20m in HTL

23.00

26.76

30.51

388.00

236.55

85.11

No change

20m in S&N 29.63 76.64


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10m S&N, 10m in HTL

20m in HTL

31.33

33.03

46.73

16.81

-50%

20m in S&N

10m S&N, 10m in HTL

20m in HTL

33.00

33.66

34.32

43.11

26.28

9.46The proposed investment of 20 million in Smith & Nephew plc, or even 10 million in each company,

will make more than 2 million after the 1st year (Tables 3.1, 3.2), which is the expected reduction in

the Fille Ter Investment Group profit, if it were to release 20 million of the shares after the 1st year. R

If Fille Ter Investment Group were to invest in the diversified market of 9.96%, they would make (20

x (1.0996)3 ) million after three years, that is, 26.59 million. Our proposed investment of 20 million

on Smith & Nephew plc would more than double this figure - 76.64 over the next three years (Table

3.1). Even an investment of 10 million in each company will bring nearly twice this amount -46.73

m (Table 3.2).

With an equity beta of 1.8, Fille Ter Investment Groups customers will be expecting a rate of return

of 15.13% per annum. To meet their expectation, the proposed investment must bring at least 20 x

(1.1513)3 million over the last 3 years, that is, 30.52 million. By investing 20m in Smith & Nephew

plc, over twice the amount of this return can be achieved after 3 years - 76.64 m (Table 3.1). Table

3.3 indicates that a higher return could be achieved by investing in the diversified market at 9.96%

per annum at a low risk rather than in Huntleigh Technology plc. However, investing in the diversified

market only will not bring the rate of return that Ter Fille Investment Groups customers are

expecting.

Hence, we propose the total of 20 million to be invested in Smith & Nephew plc, whose beta value is

less than 1 and reasonably safe for investment.


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ChapterDiscussion

4

Following further research on Smith & Nephew plc and Huntleigh Technology plc, a SWOT analysis

was carried out on both Groups, based on their annual reports, and the main points are summarised

in Tables 4.1 and 4.2.

Table 4.1: SWOT analysis for Smith & Nephew plc

Strengths

1. The markets on which Smith & Nephew plc focuses continue to demonstrate robust growth and

are expected to benefit for many years to come from an ageing population, active lifestyles and

the development of less invasive techniques in orthopaedic and endoscopic surgery.

2. Smith & Nephew plc is listed on the London Stock Exchange, the New York Stock Exchange, the

FTSE100 and FTSE4Good.

3. Smith & Nephew plc has a share value which is nearly 6 and a shareholders return which is

significantly higher than the FTSE100.

4. In order to maintain its market leadership position, Smith & Nephew plc has acquired at least

medical devices six companies since January 2002.

5. Smith & Nephew has a 29% share of the global arthroscopy market, 8% share of the orthopaedic

market by value and 20% of the advanced wound management market share.

6. Smith & Nephews continuing innovation in advanced wound management products and thepotential for further penetration of moist wound healing and wound bed preparation techniques

should fuel expansion of this market. For 2004, Smith & Nephew expects increasing growth in its

orthopaedics business, improved growth rates in endoscopy supported by the launch of a new

progressive scan camera system and the next generation varicose vein removal system, and

sustained growth in the advanced wound management business.

7. Smith & Nephew continues to achieve strong sales growth in these markets and is demonstrating

its ability to grow market share in orthopaedics and maintain market leadership in endoscopy and

advanced wound management.

8. Smith & Nephew plc has a diversified market, consisting of orthopaedics, endoscopy and woundmanagement, which dilutes the financial risks in the event that one of the sectors faces major

difficulties.

9. Smith & Nephew plc operates mainly in the UK and the States and, with a sales operation in over

38 countries, Smith & Nephew plc has diluted its financial risks in the event of political upheaval


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or loss of contract on some of the countries.

10. Smith & Nephew plc has been experiencing a high, though sharply decreasing, growth in sales of

9% in 2003 (12% in orthopaedics, 3% in endoscopy and 10% in wound management), compared

with 15% in 2002.

11. Smith & Nephew plcs policy of re-investing for higher growth will eventually result in a higher

shareholders return.

12. An increasing consumer awareness of available healthcare treatments through the Internet and

direct-to-customer advertising. This has led to increased consumer influence over product

purchasing decisions.

13. Experienced managers responsible for sales, marketing and product development in each areas

has resulted in increased sales momentum in the US.

14. The Groups sales force, which includes independent commissioned sales agents, increased by

5% to 2,612 during 2003.

15. Smith & Nephew plcs turnover has been on the increase during the last decade to 1.18 billion in

2003.

16. Profit on ordinary activities before taxation has improved 15% since last year to 230.1 million in

2003.

17. Basic earnings per ordinary shares increased by 31% since 2002 to 15.92p in 2003.

18. Smith & Nephew plcs investment on research and development increased by 5.5m (9%)

compared with 2002 (representing 5.7%of sales in 2003 compared with 5.5% in 2002) to invest in

innovative technologies and products to differentiate from its competitors. In 2003, 20% of Smith

& Nephews sales were from products introduced in the last three years.

19. Over the last four years, Smith & Nephew has transformed its business into a high technology,

high performing global medical devices company. During that period, the Group has deliveredconsistent growth and high levels of total shareholder return.

20. Smith & Nephews sustainable development depends ultimately on its ability to provide a

satisfactory economic return. In 2003, the Group generated an operating return on capital

employed of 32%.

21. ORATEC products produced sales growth of 41% helping Smith & Nephew to maintain its market

leadership position in arthroscopy with a market share of 29%.

22. Energy consumption increased by only 1% in 2003 when compared to 2002 despite increased

turnover of 11% for the Group.

Weaknesses-S&N

1. A feature of the orthopaedic business (whose finished goods stock makes up 47% of the Group

total) is the high level of finished product stock required, some of which is located at customer


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premises and is available for customers immediate use.

2. Higher than normal revision rates in respect of the macrotextured femoral knee component

prompted a voluntary withdrawal of the product from the market on 18 August 2003. This must

have had an adverse effect on Smith & Nephew plcs reputation.

3. The falls in the stock market values over the last four years have adversely affected the funding

levels of both of Smith & Nephews major defined benefit plans in the UK and US.

4. Marketing, selling and distribution expenses budgets were 440.1m, representing 37.3% of sales

in 2003, the same percentage as in 2002, which is quite high.

5. The growths in sales from the other geographical locations have also decreased from 2002 to

2003.

6. Much of Smiths revenue is obtained in the devaluated US dollars, from the States. However,

financial statements of the annual report are given in British pound sterling, which is strong in

value; this has the effect of masking the true profits derived from sales in the States.

Opportunities-S&N

1. The worldwide orthopaedic market (excluding spine) served by the Group grew by 13% in 2003

and is currently worth more than 5.9 billion per annum. Smith & Nephew holds an 8% share of

this market by value.

2. These markets are characterised by an increase in the average age of the population caused by

the immediate post-World War II baby boomer generation approaching retirement, increased

longevity and more active lifestyles. The ageing population combined with more active lifestyles

and increased affluence has created significant demand for more effective healthcare products

which deliver improved outcomes through technology advances.

3. Pressure to resist increases in overall healthcare spending has led healthcare providers todemand products which minimise the length of hospital stays and surgeon and nursing

resources.

4. The advanced wound management business is focused on the treatment of chronic wounds of

the older population and other hard-to-heal wounds such as diabetic foot ulcers, burns and

certain surgical wounds and is therefore also expected to benefit from demographic trends.

5. The market for advanced wound treatments is relatively unpenetrated and it is estimated that the

potential market is significantly larger than the current market of 1.6 billion. This increased

penetration is expected to be driven by improved outcomes from new technology, health

economic benefits, demographics, increasing nursing shortages, quality of life expectations and

education of healthcare providers to convert from traditional to advanced treatments.

Threats S&N1. USA contributes to 54% of Smith & Nephew plcs sales of ongoing operations. The significant

decrease in growth in sales from USA from 14% in 2002 to 4% in 2003 could have a major


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negative financial impact on Smith & Nephew plc if the trend continues in this way. This decrease

in growth was contributed by the increased re-use of arthroscopic resectionblades and decreased

business from one of its largest customers, HealthSouth.

2. Smith & Nephew has been sued by ArthroCare Inc., for infringement of three US patents related

to certain bipolar radio frequency products. This could have adverse effects on the Groups

reputation.

3. Principal global competitors in the orthopaedic market and their estimated global shares, are

Zimmer (21%), Stryker (19%), De Puy/Johnson & Johnson (18%), Biomet (11%) and Synthes-

Stratec (9%). Increased competition and unanticipated actions by competitors or customers could

lead to downward pressure on prices and/or a decline in market share which would adversely

affect Smith & Nephews results of operations and hinder its growth potential.

4. The Group is largely dependent on future governments providing increased funds commensurate

with the increased demand arising from demographic trends.

5. The Group reports its results in Sterling. However based on 2003 results, only 8% of group

turnover arises in the UK. If the Sterling exchange rate should strengthen against the US Dollar

and/or Euro then group turnover and operating profit would be lower on translation into Sterling.

6. Should products malfunction, causing damage to or impairing the repair of body functions, Smith

& Nephew may become subject to liability, which could be substantial and harmful to the Groups

reputation which is crucially dependent on product safety and efficacy.

7. Some of these competitors may have greater financial and marketing resources, technological

competence or innovative ideas than Smith & Nephew.

8. Failure to make Successful Acquisitions:

9. Attracting and Retaining Key Personnel

10. Regulatory approval of new products may entail a very lengthy process. Failure to comply withsuch controls could result in withdrawal of approval to sell a product in a country or temporary

closure of a manufacturing facility.

11. If Smith & Nephew fails to successfully enforce its intellectual property rights, its competitive

position could suffer.

12. Continual Development and Introduction of New Products, to satisfy customers needs and

preferences and to remain competitive, is a costly, lengthy and uncertain process and may affect

price levels in the various markets in which the Groups business units operate.

13. The Groups manufacturing production is concentrated at seven main facilities in USA and UK. If

major physical disruption took place at any of these sites, it would adversely affect the results of

operations.

14. As a growth industry, medical device companies currently have higher stock market valuations

than other industrial companies. If market conditions change, or other companies in the sector fail


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to perform, or the Group is perceived to be performing less well than the sector, then the share

price rating of the Group may be adversely affected.

15. Because the Group has operations in 32 countries, political and economic upheaval in those

countries or in the regions surrounding those countries may impact the Groups results of

operation. Furthermore, legislative measures in a country could result in changes in tariffs, import

quotas or taxation that could adversely affect the Groups turnover and operating profit. Terrorist

activities and ongoing global political uncertainties, including conflict in the Middle East, could

adversely impact the Group.

Table 4.2: SWOT analysis for Huntleigh Technology Plc

Strengths-HTL

1. Huntleigh Technology plcs share price and share holders return have remained above those of

the FTSE100 for the last decade.

2. Huntleigh Technology plcs has renowned innovation, expertise and commitment to research and

development, through which it has been able to develop its business internationally. Huntleigh

Technology plc Group continued to invest significantly in research and development, spending

5.3 million or 3.1% of Group manufactured product turnover during 2003.

3. 2003 saw the launch of two leading-edge hospital beds: The Contoura 480 and 560 electric

profiling beds have a unique, patented profiling mechanism designed to reduce pressure ulcer risk

and enhanced safe working load of 267kg.

4. Several major orders were won during the year with complete hospital bed replacement

programmes, involving several thousand beds, being undertaken in the London area.

5. Huntleigh Technology plcs successful Totally Managed Equipment (TME) contracts in the United

Kingdom will allow the group to leverage other product lines.

6. The launch of the Flowtron Universal DVT Prophylactic system marked a highlight for the year

and rapid and positive market response, signifying Huntleighs continuing investment in leading-

edge design and innovation.

7. 2003 also saw investment in bespoke production equipment and a re-engineering of elements of

the manufacturing process, elevating efficiency, flexibility, quality and materials management and

the minimisation of waste levels.

8. The highlight of 2003 was the world-wide release of the Intraoperative Doppler Probe which

enables blood-flow to be assessed during reconstructive surgery and which received praise from

both vascular and plastic surgeons.9. The Group has forward contracts and options for approximately 80% of its US Dollar exposure for

2004 and around 70% for 2005 at $1.44 to the pound. It has cover for about 80% of anticipated

Euro income for 2004 at 1.48 to the pound. This is likely to boost up profit due to the speculated

increase in US dollar value as from November 2004, according to the Department of Trade and


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Industry.

10. Globally, Smith & Nephew plc supplies over forty types of support surface, ranging from the

simplest foam overlay through to complex rotational therapy systems for Intensive Care, thereby

diluting the financial impact resulting from possible drop in sale of one or more products.

11. Growth in sales ofPAC systems was led by continued strong performance of the Nimbus range

and the introduction of other price-competitive product lines in the non-acute sector.

12. In the United States strong sales performance was underpinned by major contract awards

including that of sole supplier to Amerinet as part of their prestigious Choice product line,

granted to only the highest quality products which meet or exceed industry standards in design

and manufacture. Amerinet is one of the leading healthcare providers who operate a network of

over 1,800 hospitals and 18,000 non-acute care facilities.

Weaknesses-HTL

1. Huntleigh Technology is not ploughing back enough money into the business for growth. Hence,

its share price is not expected to increase significantly in the next few years unless the group re-

invest more into the business.

Opportunities-HTL

1. The Highlite lightweight, transportable transfer system was launched in 2003. This device

allows wheelchair-bound and less mobile individuals to lead a far more active life and will be of

interest to many market sectors, such as hotels, the emergency services and social services.

2. As nurse injury becomes less acceptable and patient independence more important, the

requirement for electric profiling beds and other complementary equipment continues to increase.

3. A recent independent audit of 6,000 hospitalised patients across five EU countries reported thatpressure ulcers present on one in every five individuals. These have potential negative effects on

hospital throughput and infection rates as well as causing distress to patients. The problem of

pressure ulceration has also been highlighted by the National Excellence of Clinical Excellence

through its report on Pressure Ulcers in 2003, whereby the heavy cost to the NHS and effect on

quality of life of patients were emphasized. This is likely to trigger higher demand on PAC

equipment.

4. The prevalence of obesity has increased dramatically in recent years and continues to rise;

hence, there is an anticipated rise in sale of Huntleigh Technology plcs products.

5. The incidence ofP

eripheral Vascular Disease (P

VD) continues to increase due to the ageingpopulation in the western world, hence an opportunity for increased sale of Huntleighs Dopplex

range of Doppler products in assessing blood-flow in the limbs and helping in the screening of

patients with PVD.


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6. The two leading-edge hospital beds, the Contoura 480 and 560 electric profiling beds are

already proving to be a major success, and, based on this success, further significant progress

could happen in 2004. A growing market for electric beds in countries other than USA could be

possible in the years to come.

7. The Millennium Homes project, now marketed as Huntleigh Insight, continues to progress well

with pilot sites firmly established. It is anticipated that this new technology goes further than

conventional home monitoring and enables elderly or frail people to live independently in their

own homes.

The issue of travel related DVT continues to receive considerable press coverage. However, the

problem of blood-clots associated with surgery or hospitalisation is less well known. IPC is now

widely acknowledged to play a major role in helping to reduce this risk, hence the opportunity for

the wider use of IPC range of products.

9. Rentals continued to grow at a faster rate than sales, reflecting tight capital budgets in many

countries. This could be an opportunity for Huntleigh Technology plc because its rental sector is

growing faster than the sales.

Threats-HTL

1. Huntleigh Technology plc cannot afford to lose the large Amerinet contract since this will have

a major negative financial impact.

2. Continuing pressure on healthcare budgets will have a negative financial impact on Huntleigh

Technology plc, who relies significantly on contracts from the NHS.

3. Huntleigh Technology plc does not seem to be re-investing enough into the company and this

will probably have an adverse effect on its share price in the longer term.

4. The component geographical parts of Group turnover could be affected by the relativestrength of the Euro and weakness of the US Dollar.

5. The weakness of the US dollar masks an encouraging performance by Huntleigh Technology

plcs American subsidiary which grew 7% in local currency terms.

6. The Iraq war, uncertainty in the Middle East and the SARS outbreak in the Far East severely

reduced sales during the first half of the year. This situation could repeat, should there be

social and political and legal upheaval in the Middle East.


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ChapterConclusions

5

Based on their company reports, and Figures 2.1-2.9, both Smith & Nephew plc and Huntleigh

Technology plc demonstrate potential robust growth and are expected to benefit for many years to

come from an ageing population and active lifestyles. This is because they provide specialist

equipment to the frail and elderly which has always been on demand, despite external factors, even

following September 2001 (Figs. 1.2, 1.4. 1.5). Table 4.1 and 4.2 indicate that both Smith & Nephew

plc and Huntleigh Technology plc have sound backgrounds and operate in an expansive

environment, as opposed to a contracting environment. Although Huntleigh Technology plc is

performing well, it is not growing according to the rate of return expected by Ter Fille Investment

Groups investors. Huntleigh Technology plc could increase its rate of return by re-investing back in

the group and enhance growth. Today it is accepted that money tied up in Current Assets (Stocks,

Debtors, Cash at Bank) earns nothing, or at most far less than we can get by investing this same

amount in the efficient running of the business (Gasking, 1993). We would expect both Smith &

Nephew plc and Huntleigh Technology plc to perform as they are, or even better over the next few

years.

By investing 20,000 on Smith & Nephew plc, Ter Fille Investment Group will be doing better than

investing in the diversified market, will achieve more than twice the return expected of 15.15% per

annum by its customers, which is worth the additional risk. Should there be an economic downfallthat will have an impact on the financial performance, for example, causing the expected dividend to

half in value, then a 20 million investment in Smith & Nephew plc should still bring 43.11 million

after 3 years, which is more than the expected return of 30.52 million, based on a rate of return of

15.13% for an equity beta of 1.8. Huntleigh Technology plc could become more attractive for

investment if it re-invests some of its profit back in the company for future growth.

Smith & Nephew plcs Operating profit margins will improve if the effective rate of exchange of the

Euro compared with the US Dollar increases and will be reduced by a relative strengthening of the

US Dollar. The effective rate of exchange will determine the average cost of finished goodspurchased by the Groups selling operations from its manufacturing operations and will be affected by

actual rates of exchange, forward purchases of foreign currency and stock utilisation. Smith &

Nephew plcs operating profit margins will improve if the effective rate of exchange of the Euro


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compared with the US Dollar increases and will be reduced by a relative strengthening of the US

Dollar. The effective rate of exchange will determine the average cost of finished goods purchased by

the Groups selling operations from its manufacturing operations and will be affected by actual rates

of exchange, forward purchases of foreign currency and stock utilisation.

Although operating sales turnover for Huntleigh Technology plc has increased over the past few

years, operating profit has decreased. The opposite is true for Smith & Nephew plc. Smith & Nephew

had an average of 7,451 full-time equivalent employees in 2003, of whom 1,600 were located in the

UK, 3,177 were located in the US and 2,674 were located in other countries. The general level of

employee satisfaction was 82%. This could explain the higher sales to employee ratio for Smith &

Nephew plc in Fig. 2.3.

Smith & Nephew plc enjoyed an increase in growth of ongoing operations of 11% from 2002 to 2003,

which contributed to a 6% increase in the Group turnover, and a reduction in cost of sales at

345.1m, representing 29.3% of sales compared to 29.7% in 2002. This improvement arose from

manufacturing cost and efficiency savings and transactional currency benefits from the decline in the

value of the US Dollar reducing the product cost in many countries outside the US, notably in Europe

and Australia. Smith & Nephew plcs aim is to accelerate underlying sales growth within the

orthopaedics business to high teens and to grow endoscopy and advanced wound management

sales in high single digits. It also aims to increase its operating margins by around 1%. The Group is

well placed to achieve strong underlying sales growth in 2004 and plans to invest in expanding its

sales force, with at least 10% growth planned in 2004.

Based on the findings in this report, we recommend that 20 million be invested in Smith & Nephewplc for a sensible return.


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Appendix A:Huntleigh Technology plc financial sheets


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Appendix B:Smith & Nephew plcs financial sheets


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( 2004a; 2004b;Atrill 2003;Gasking 1993;Huntleigh Technology PLC 2004;Pike & Neale2003;Samuels, Wilkes, & Brayshaw 1999;Whiteley 2004;Zmijewski 1983)

References

http://fame.bvdep.com/cgi/template.dll . 2004a.

Ref Type: Internet Communication

http://uk.biz.yahoo.com/tech/h/htl.l.html . 2004b.

Ref Type: Internet Communication

Atrill, P. 2003,Financial Management for Non-specialists, 3rd edn, Prentice Hall, London.

Gasking, T. 1993,Perfect Financial Ratios - All you need to get it right the first time Century Business, London.

Huntleigh Technology PLC 2004,Huntleigh Technology PLC Annual Report and Accounts, The Design Portfolio, a

member of the Flathill Communications Group Plc.

Pike, R. & Neale, B. 2003, Corporate Finance and InvestmentPearson Eduction Limited, Harlow.

Samuels, J. M., Wilkes, F. M., & Brayshaw, R. E. 1999,Financial Management & Decision MakingInternational

Thompson Business Press, London.

Whiteley, J. 2004,Mastering Financial ManagementPalgrave MacMillan, New York.

Zmijewski, M. E. 1983, "Predicting corporate bankrupcy: An empirical comparison of the extent of financial

distress models", University of NewYork.

Assignment FM June2004

Documents

Transcript of Assignment FM June2004