It’s not immune from inflation but Smith & Nephew is a quality business. Keep buying

The medical equipment specialist is still recording high-teens operating margins even when it is not quite on top form, says Russ Mould

One common refrain from companies during the second-quarter reporting season has been how their input costs are rising, be they commodity, raw material, shipping or even wage costs. Even the medical equipment specialist Smith & Nephew is not proving immune and this may explain why the shares slid quite so far after last month’s interims.

Despite this stumble, Questor continues to see the company as a potential post-pandemic recovery play as patients start to undergo medical procedures in greater numbers.

The firm’s first-half figures fitted neatly with our thesis. Sales rose by more than a quarter, year on year, underlying operating margins more than doubled and the board agreed an unchanged dividend of $0.144 a share. Nor did the company make any formal changes to the outlook for 2021: Smith & Nephew still expects underlying sales growth of 10pc to 13pc and record profit margins of 18pc to 19pc. However, that guidance now assumes surgery volumes largely return to normal in the second half, so that scenario is now the base case rather than a source of potential positive surprises. Increased investment and freight costs continue to weigh. Analysts accordingly trimmed their forecasts and the shares erased all of the gains made since our initial analysis in March. We shall therefore simply have to be patient. Smith & Nephew has not become a “bad” business. Net debt is relatively low, underlying interest cover is good and the business is still recording high-teens operating margins when it is not quite on top form. Medical procedures should increase in number once patients and surgeons feel a procedure can

Smith & Nephew Buy

The forecast price-to-earnings ratio of about 35 is deceptive

be carried out as safely as before. Consumables and sports medicine sales could rebound too and restructuring costs may come down.

The earnings downgrades leave the stock on a forecast price-to-earnings ratio of about 35. That is not bargainbasement territory, but it is a bit deceptive. Earnings per share got as high as $0.88 in the past (or around 64p at current exchange rates) and a return to that level would take the multiple down to the low 20s, a reasonable price for a leader in its field that has a history of double-digit percentage returns on capital. This is another chance to buy into the recovery story.

Questor says: keep buying Ticker: SN

Share price at close: £13.84

Update: Yellow Cake

One company that marches to its own beat is Yellow Cake and this remains one of its key attractions. Investors who apply strict environmental, social and governance criteria will just walk on by, but their disdain could offer a value opportunity to more hard-nosed portfolio builders.

Uranium offers incredible value as a source of “base load” power, relative to coal, gas or oil, and supply is constrained. No wonder, therefore, that boss Andre Liebenberg continues to sanction the acquisition of more U3O8, better known as uranium oxide (or “yellow cake”), to store at its Canadian warehouse. The firm has raised more than £160m from investors and increased its holdings to 13.7m pounds of U3O8, enough to give the company a net asset value of 250p a share.

Yellow Cake’s shares do therefore trade marginally above book value, which lessens their attraction, as some future good news is already priced in and there is greater risk should anything go wrong. But if uranium prices keep rising that may not be the case forever.

Other uranium stocks are paying attention. Toronto-listed Energy Fuels has gained 176pc in the past year, New York-traded Denison Mines is 116pc to the good and Cameco, also Us-listed, has put on 65pc. Granted, they are more direct beneficiaries of rising uranium prices as they are miners and producers and their costs are more fixed than those of Yellow Cake, which has to buy the commodity. We already have a paper profit on our first analysis of the Aim-quoted firm a year ago but there could be more to come if the uranium market’s fundamentals play out as expected.

Questor says: keep buying

Ticker: YCA

Share price at close: 262p

Read Questor’s rules of investment before you follow our tips: telegraph.co.uk/go/ questorrules; telegraph.co.uk/questor