Smith & Nephew (SN.) gained momentum in key end markets during the first quarter. Since the firm remains on target to meet our expectations for the full year, we are maintaining our fair value estimate.
During the quarter, sales grew 6% (4% in constant currency) to about $1.1 billion. Orthopaedics were stronger than we expected with 4% reported growth and 2% in constant currency, which was particularly impressive given the tough comparables from last year. Growth could accelerate during the rest of 2011 as a result of much easier comparables in the last three quarters of 2010. In the first quarter, Smith & Nephew appeared to steal share from its competitors in knees, turning in 5% constant currency growth and 10% growth in the important US market. The firm's new Verilast bearing technology for knees appears to be resonating with patients thanks to its 30-year wear claim; Visionaire patient-matched instruments also helped the firm grow above market rates in knees. In hips, sales declined 2% in constant currency, as the firm's market-leading Birmingham hip resurfacing system remains embroiled in the metal-on-metal controversy. Endoscopy sales reported 8% growth (6% in constant currency), driven primarily by a rebound in its arthroscopy (sports medicine) repair products, which showed ongoing momentum from recent shoulder and hip product launches. Advanced wound management led the charge in reported growth at 9% in the quarter, 6% in constant currency. Smith & Nephew continues to expand in the negative-pressure wound therapy niche that Kinetic Concepts (KCI) has dominated for more than a decade.
From a profitability perspective, Smith & Nephew was modestly weaker than we expected. The firm turned in an adjusted operating margin of 23%, or about flat year over year. Our estimates for the full year had called for slight expansion from the 23% operating margin produced in 2010. Management said it expects to reinvest expected operating efficiency gains in 2011, so we've trimmed our profitability assumptions slightly for the year. This small and short-term change wasn't enough to move our fair value estimate, though. Free cash flows grew a solid 6% year over year, and Smith & Nephew continued to deleverage its balance sheet. At the end of March, the firm's net debt position stood at a highly manageable $351 million.