Smith & Nephew(LSE: SN) has lost 7.5% of value in less than a day after US rival Stryker announced a $2bn stock buyback programme.That shouldnt have come as a surprise I did warn youearlier this year, after all.
While Stryker may abandon its ambitious plan to buythe UK medical device maker, weakness in Smith & Nephewstock indicates that it may be a good time to add it to your wish list.But at what price should you actually buy into the stock?Here is myanswer, and heres why you should also pay attention to Shires (LSE: SHP) rally, which looksrather convincing.
I am not a fan of the concept big is beautiful,’ Smith & Nephew chief executive Olivier Bohuon said at a conference on healthcare in January, when itwas on the verge of receiving a takeover offeraccording to market rumours. To be fair,the companyhas been a takeover target for about a decade: its equity value has doubled over the period, but most of the gains in its stock value have come in the last 24 months.
Of course, Smith & Nephewshareholdersare concerned now butMr Bohuon may be right.
If so, the companywill likely continue to deliver value to shareholders for a long time, and a 7.5% drop in its stock price should be perceived as positive news for value hunters. After all,Smith & Nephew is expected to deliver higher revenue growth in 2015 than in 2014, whilea further improvement in trading profit margins seems likely. Positive contribution to net earnings is also expected to come from a marginally lowercorporate tax rate.
Furthermore,currency swings may have a minimal impact on 2015 revenues: its balance sheet is solid, and net leverage is manageable. Finally, core profitability may rise faster than expected on the back of ad-hoc cost-cutting measures, so there could be room for an increase in the payout ratio.
S&N is still expensive, however, so I am not saying it is time to buy. But this is one stock to watch, particularly if its valuation drops another 20% or so from here to around 900p.Incidentally, Johnson & Johnsonand private equity firmscould easily put forward opportunistic bids if S&N traded in the 800p-950p range.
Shire On A Roll
Shire, another company operating in the broader pharmaceutical world, is a different story.Its shares havedrawn my attention for a few weeks now.
Shire shareholders were under pressure to sell when the merger withAbbViewas called off in mid-October, but since then weakness in their shares has turn out to be a great buying opportunity: the shares have recorded a 39% pre-tax return, excluding dividends.
Shire is drawing lots of attention from analysts, too and rightly so. Goldman Sachs suggests a price target of 6,400p, which is way too bullish, but a 10% rise to 5,700p is very possible to the end of the year.
Shire is a solid company that has proven to be able to allocate capital efficiently over time. Its a tad more expensive than S&N which is justified by a higher growth rate, higher profitability, lower net leverage and a decent pipeline of drugs but there you go: high-quality stocks do not come cheap.
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