Smiths Group and Pharmaceutical Stocks

Friday, March 22, 2019 - 10:04

“Having enjoyed a strong finish on Thursday amid a big slide in sterling, the FTSE 100 is modestly lower on Friday as news that the immediate cliff edge for Brexit is being postponed drives a recovery rally in the currency.

“Regular observers of the equity markets may long for the day when they don’t also have to be on top of currencies but, with a no deal outcome only delayed for now rather than averted entirely, further volatility is likely in the coming weeks.

“Healthcare stocks continue to slide after a big biotech disappointment in the US yesterday, while companies which derive a significant chunk of their revenue in dollars, such as British American Tobacco and Unilever, are also weakening as the rebound in the pound hits the relative value of this income,” says Russ Mould, Investment Director at AJ Bell.

Smiths Group

“The wheels are in motion for the break-up of industrial conglomerate Smiths Group with the FTSE 100 member guiding for a separate listing on the stock market of its medical arm in the first half of 2020.

“The decision to separate out the Smiths Medical division, first announced last November, wasn’t a surprise as it doesn’t really fit with the rest of the engineering group whose interests range from airport security scanners to components for the aerospace and construction industries.

“Half-year results show that the medical arm continues to be the weak part of the group with underlying revenue falling by 3% and underlying operating profit falling by 12%.

“There is a trend for companies to have a tighter focus and not be all things to all people. Separating business divisions can help the parent company be leaner and meaner, and for the orphaned operations to have a new life of their own with potentially more entrepreneurial decisions by management.

“As a standalone business, one cannot rule out Smiths Medical being subject to further takeover interest down the line, despite the failed merger with ICU in 2018, an unsuccessful attempt to sell the business in 2013 and a rejected private equity approach in 2011.

“It is easier for a suitor to swoop on a separated business than to attempt discussions with a conglomerate owner which may be slow with its negotiations and decision-making and may not have realistic expectations on valuation.

“One could even speculate that the wheels are in motion for a further break-up of Smiths Group. The next step might be to separate John Crane, which is Smiths’ energy and chemicals engineering arm. It reported 5% underlying profit growth in the first half period. Demerging the business could allow it to pursue mergers and acquisitions to potentially accelerate growth.

“The downside of separating a business from a conglomerate is that it removes or reduces a diversification cushion. Theoretically if one unit underperforms then another comes to the rescue in terms of supporting group earnings – which it exactly what’s happened in the latest results with John Crane and Smiths Interconnect (high-speed connectivity for various markets including defence and rail) propping up the group amid weakness in the Smiths Medical and Smiths Detection units.”

Pharmaceutical Stocks: Biogen, AstraZeneca, Glaxosmithkline

“The high-risk nature of the pharmaceutical sector has been laid clear by Biogen losing more than $18 billion from its market value yesterday after scrapping two Alzheimer drug trials.

“Several other pharma groups have also failed with their Alzheimer developments in recent years including AstraZeneca and Eli Lilly who stopped a global trial last summer after a panel found their treatment was unlikely to meet its goal.

“Biogen’s setback and the scale of its share price slump has spooked investors across the pharma sector with AstraZeneca falling 1.4% and GlaxoSmithKline sliding 0.4% on Friday morning in response.

“Sadly, drug setbacks are par for the course when it comes to investing in this part of the market. Not every treatment works and investors should understand there are major risks to all new developments until they are fully approved and in active use. Even then there is the commercial risk of generic copycats once patents expire.

“Ultimately the real disappointment is the struggle in finding a way to help people who have Alzehimer’s. Biogen’s situation will add to the sector’s frustration but it is unlikely to stop pharma companies from continuing to work on finding a solution for those suffering with the disease.”

These articles are for information purposes only and are not a personal recommendation or advice.

The daily market update is written by Russ Mould, AJ Bell’s Investment Director and his team. The article highlights the movement in the main index, winners and losers on the day and any macro-economic announcements.