Smith & Nephew accused of inflating profit margins

Smith & Nephew, the troubled FTSE 100 artificial hip maker, has been accused of deploying “aggressive” accounting techniques to bolster its profit margins by a firm that bills itself as a group of “financial detectives”.
London-based Dragoneye, which conducts independent research for short-seller investors, has raised the question of whether Smith & Nephew has inappropriately deferred its costs and failed to adequately account for its stock write-offs.
Dragoneye calculates that these accounting techniques have inflated Smith & Nephew’s trading profit margin, which was 17.5 per cent last year, by 1.7 percentage points. Forty per cent of the annual bonus payable to chief executive Deepak Nath is tied to Smith & Nephew’s profitability.
Smith & Nephew said it was “absolutely not the case” that it had inflated its profit margins through aggressive accounting techniques and the report was factually incorrect. Its shares have fallen by 6.1 per cent since the report was published on October 1.
Nath is trying to rebuild investor faith in Smith & Nephew, a specialist in hip and joint replacements and wound care, after a period of inconsistent trading and executive churn.
His task may be complicated by activist investor Cevian Capital, which has built a 5 per cent stake. Sources familiar with Cevian’s thinking say the firm wants deeper cost-cuts and a reorganisation of Smith & Nephew’s divisions to increase transparency and accountability.
The research by Dragoneye, run by Julian Hull, a former researcher at short-seller ShadowFall, highlights that Smith & Nephew’s inventory had risen to its highest level in two decades.
Meanwhile, the quantum of Smith & Nephew’s inventory write-offs is at its lowest level since 2019. Dragoneye estimates that if write-offs had been maintained at the three-year average, last year’s trading profit would have been $60 million (£45 million) lower.
Smith & Nephew said it has been seeking to better align manufacturing with demand, and that lower inventory charges were one of the intended benefits. The company has not changed its policy on inventory charges.
Dragoneye also questions why there has been an increase in the value of assets under construction within Smith & Nephew’s intangible asset disclosure. These increased from $13 million in 2018 to $178 million last year.
Assets begin depreciating only once they are in use. This, Dragoneye says, has enabled Smith & Nephew to defer amortisation costs, resulting in 100 basis point boost to trading profit margin, when compared with the previous year’s rate of amortisation.
Smith & Nephew said the accusation that it was deferring amortisation was incorrect and that the report “cherry picked” some assets to give a misleading picture.
Short interest, a proxy for short-selling, stands at 3.3 per cent of Smith & Nephew’s outstanding shares, according to data from S&P Global. Large shorts include AKO Capital, a hedge fund known for detailed, fundamental analysis.