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Low-growth medical technology still sells poorly today, even worse when significant litigation risk is unknown. Koninklijke Philips NV (New York Stock Exchange: PHG) recovered strongly from late-2022 lows, supported by some strong quarterly beats Compared to expectations, but the stock is still down another third. my last update – Re-emphasize “How much worse can it be?” These are dangerous words when it comes to investing.
Phillips’ stock price seems undervalued based on what I believe to be a conservative assumption and a multiple, but the reality is that the market is poised for low to mid-single-digit earnings growth. I don’t really love medical technology that has / Or his EBITDA margin under 20%, and that’s where Philips is right now. I can understand its appeal not only from a healthy dividend yield and cash flow, but also from a value perspective. While they can cover future litigation costs, investors considering these stocks will at least have more exposure to lawsuits related to the company’s sleep apnea and ventilator products. Until then, you should be aware of the risk that this becomes a value trap.
Beats Philips again in Q1, no raise
Management chose to maintain what should have been relatively conservative guidance for the full year, building on a strong fourth quarter (compared to sell-side expectations) and despite solid performance. . Given the sentiment surrounding the name, “underpromising and overgiving” may not be such a bad strategy.
Revenue increased 6% on an organic basis, 3% higher than expected. Diagnosis and treatment (or D&T) is the largest, with a difference of almost 7%. D&T revenue increased 15%, with double-digit growth in ultrasound and image-guided therapy driving his mid-single-digit growth in imaging. Connected care revenues were up 2%, up 3%, with double-digit growth in monitoring and analytics. Personal Health was down 6%, but still about 2% above expectations.
Supply chain improvements and productivity initiatives (large layoffs and reprioritization of R&D) and improved sales volumes are improving margins. Adjusted EBITA was up 48% to top 74%, with margins up his 240bp to 8.6%. D&T profit more than doubled, margin increased 540bp to 11.3% and Connected Care margin improved from 0.4% to 2.4%. Personal Health profits were down 18% and margins were down his 210bp to 13.2%. All segments exceeded expectations, with Personal Health up 9%, D&T up 76%, and Connected Care up 92%.
Not upgrading guidance may prove to be conservative. Orders were flat, with his double-digit growth in D&T (driven by strong growth in image-guided therapy) offsetting weakness in connected care. As the year goes on, Phillips should benefit from his pricing actions at D&T late last year and improved demand in North America if staffing levels improve. Rebounding demand in China should also be positive for personal health.
In terms of margins, there is still room for further exploitation by improving supply chains, reducing headcount and reprioritizing R&D.
Litigation unknowns still weigh on outlook
Philips has taken a further provision of €575 million for costs and liabilities related to the recall. dream station In addition to the recall of the CPAP machine and ventilator business, 95% of scheduled replacement or repair kits dream station Has completed.
While this is not a trivial step, there are still significant uncertainties regarding the consent decree with the FDA and the outcome of future litigation (including possibly DOJ subpoenas that could lead to criminal liability/penalties). Recent FDA communications (483 and 518(b) The letter) is a serious failure of duty of care on the part of Philips, highlighting that officials believe the penalties here could run into the hundreds of millions of dollars. I don’t think it will, but it’s not guaranteed at this time.
My views on the product liability/personal injury lawsuits facing Philips have not changed much. At this time, even the number of plaintiffs/plaintiffs is unknown and the lead litigation (providing guidelines for potential global settlement costs) may not take place until late 2024 (at the latest). is high.
Back in December 2022, the company provided an update on foam and foam damage testing. Dream Station I system. These tests were reviewed by 3rd party toxicologists using his 5 independent labs. The results showed that when the device was used as labeled (that is, cleaned without ozone), there was a low level of foam degradation and a low risk from foam particles. Released. Whether or not this will convince the jury remains to be seen, but it is their defense that foam degradation (and subsequent foam and associated volatile organic compound injury) is the fault of users who used ozone cleaning. Fixing may not prove persuasive.
Outlook
Management’s medium-term growth plan is not particularly ambitious, with mid-single-digit earnings growth essentially in line with market growth that can be accommodated, and margins in the low teens by 2025 and reach mid-to-late teens after 2025. It may be prudent at the moment, but the downside is that with mid-single-digit earnings growth and profit margins in his early-to-late teens, he’s unlikely to pick up a solid multiple.
Philips has some great technology. The BlueSeal magnet technology used in MRI machines is attractive, and the photon-counting technology could eventually prove important in the CT market (Philips has been developing it since 2016). but it is not yet cost effective). today). Meanwhile, the company’s image-guided therapy business has met with mixed success, with companies such as Styker Corporation (SYK) becoming more active in areas such as telemedicine, telemetry, and informatics. Please also note that as part of its restructuring efforts, Philips has chosen to focus on a smaller number of high-potential projects, which may increase the risk of its R&D execution.
I’m modeling about 4% earnings growth over the long term and free cash flow margins that end up in the low double digits. In the short term, he does not expect the EBITDA margin to hit 20% by 2027, but he believes it could return to the low teens in 2025.
If you discount those cash flows and include the estimated $4.5 billion in litigation costs, I think Phillips is undervalued by more than the mid-$20s (for ADR). Similarly, the stock looks undervalued even though the earnings multiple is less than 2x his. The problem here, though, is that even though Phillips appears to be trading at low multiples, the market tends to overlook these companies, so lackluster earnings growth combined with his EBITDA margins are it’s going to be a problem.
Conclusion
We understand why low multiples, high dividend yields and manageable liability for future cash flows are attractive to value-oriented investors. My problem is that historically value stories have been the harder way to make money in medical technology. I’m less than impressed with Phillips management’s efforts to drive better sales growth. I like our margin improvement efforts, but I also think revenue growth is important. As such, I believe Phillips stock is undervalued, but I believe it can maintain its discount to fair value for some time.
