Smith & Nephew (SN.) turned in solid third-quarter operating results. To account for recently generated cash flow, we may boost our fair value estimate for Smith & Nephew after digging into these results further.
In total, sales grew 4% on an underlying basis to $941 million. Orthopaedics grew 2% on an underlying basis as hips stabilised in the quarter even as the debate continued about metal-on-metal solutions, which has affected Smith & Nephew's flagship Birmingham hip resurfacing product. The firm will continue trying to differentiate that product from other metal-on-metal solutions in the marketplace. In the meantime, the firm's traditional hip products are picking up the slack. Also, the firm's knee sales were up 6% on an underlying basis, which looked strong to us compared to its peers, especially in this weak economic environment. The company's 30-year wear claim for its new Verilast technology appears to be boosting growth in that niche, and the success of this system and the direct-to-consumer marketing campaign surrounding it highlights that demand and mix benefits are possible for orthopaedic devices that are truly differentiated from the pack.
In its other segments, Smith & Nephew produced mixed results. Endoscopy grew 4% on an underlying basis with arthroscopy tools growing 8% but more capital intensive visualisation tools falling 19% in the quarter. While some other capital equipment and instrument companies have seen growing results in the third quarter, we remain somewhat concerned about the sustainability of that recovery. While Smith & Nephew's results in that niche keep us somewhat wary about ongoing trends in hospital capital spending, we also note that the business was affected by the company's culling of certain tools that aren't related to its arthroscopy business. In advanced wound management, though, the firm turned in 7% growth on an underlying basis, as the firm continues to steal share from Kinetic Concepts (KCI) in negative pressure wound therapy. With a key legal win for Smith & Nephew in the US in October, we expect those trends to continue.
On the bottom line, Smith & Nephew also performed admirably, maintaining a 23% operating margin in the seasonally weak third quarter. The company also generated $394 million in free cash flow through the first nine months of 2010. We still expect the firm to generate more than $550 million in free cash flow in 2010, a steep increase from 2009 when the firm only generated $401 million in free cash flow.