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Royal Philips (NYSE:PHG) announced the world's first digital CT/PET-scan at a healthcare congress in Chicago on December 1, 2013. This innovation is a breakthrough in digitization of the healthcare and diagnostics. The scan, referred to as Vereos PET/CT, provides Philips with a great competitive advantage over its main competitors General Electric (NYSE:GE) and Siemens (SI). This will support the company's results in the upcoming years. This article analyzes Philips' business and argues why the stock is an attractive investment for investors.

The company

Royal Philips was founded in 1891. The company is currently headquartered in Amsterdam, the Netherlands. The company engages in the development, manufacture and sale of innovative products in the healthcare, lighting and consumer lifestyle segments all around the world. The company focuses on innovation. Innovation is a key part of Phillips' strategy. According to Philips' corporate website:

At Philips, we strive to make the world healthier and more sustainable through innovation. Our goal is to improve the lives of 3 billion people a year by 2025. We will be the best place to work for people who share our passion. Together we will deliver superior value for our customers and shareholders.

The company started in 1891 with a strong focus on lighting. The division has been one of Philips' core businesses ever since. Nowadays, the lighting division has a strong focus on LED lighting and energy saving solutions. Sustainability is an important driver behind the innovations within the lighting segment. One of the solutions is the Philips CityTouch. The solution enables dynamic and intelligent energy control on a citywide scale.

Philips' consumer lifestyle segment has a broad product range. The most familiar products are Philips' televisions, shaving devices and coffee machines. Consumers have a growing interest in personal health, well-being and the desire to look and feel good. Philips develops products to meet the consumers demand for such products.

Soon after Philips opened their first research laboratory in 1914, the company introduced their first x-ray innovation. The innovations in the healthcare segment are very important for Philips, because these innovations directly improve the lives of people. The Vereos PET/CT scan is the latest innovation in the digitization of healthcare and diagnostics.

Vereos PET/CT

The Philips Vereos PET/CT scanner is the world's first and only digital PET/CT scanner. The scanner produces sharper images compared to traditional scanners. This enables physicians to discover tumors that would have been invisible on a traditional scan. Study shows that 9 out of 10 physicians prefer Vereos' digital images over the traditional analog images, according to the Philips Vereos website. Vereos images have several advantages compared to analog images:

  1. Up to 2x improved volumetric resolution
  2. Up to 2x sensitivity gain
  3. Up to 2x improved quantitative accuracy

As a result of the better images, physicians can improve their diagnostic skills and prescribe a better treatment plan. Also, the Philips Vereos PET/CT scanner scans faster than traditional scanners and supports a faster workflow. This improves the efficiency of the treatment and cuts the healthcare costs. Philips is proud of their innovative product. According to CEO Van Houten, it is unlikely that the competition will announce a competitive scanner soon.

Hospitals will be very interested in the Philips Vereos PET/CT scanner. Philips already pitched the scanner for several hospitals and important healthcare leaders. These presentations were a great success. Almost every participant stated that their organisation will substitute the analog scanners for the Vereos PET/CT scanner, according to CEO Van Houten. The presentations resulted in several initial order enquiries.

Healthcare division

The healthcare division is an important division for Philips. First, the healthcare solutions improves the lives of people dramatically. This is one of the most important strategic goals of Philips. Second, the healthcare segment delivers the best financial returns. The EBITA margin is the highest of all three divisions and accounts for nearly 60% of the total EBITA, according to the third quarter earnings report.

The EBITA margin for the healthcare division was 14.6% during the third quarter of this year (see graph above). The EBITA margin for the consumer lifestyle segment was 10.6% and the EBITA margin for the lighting division was 8.5% during the third quarter of this year. Philips shifts their focus from the less profitable lighting and consumer lifestyle divisions toward the more profitable healthcare division.

I expect that the healthcare sales gets a boost next year following the introduction of the new Vereos PET/CT scanner, because it is the world's first and only digital scanner. This enables Philips to negotiate attractive deals, without providing customers with significant discounts. This will support the healthcare division's EBITA margin next year.

Stock market

Philips' shares are listed on both the Amsterdam Stock Exchange and the New York Stock Exchange. The stock rallied after Philips announced better-than-expected third quarter results on October 21, 2013. The shares closed at $33.92 on Friday, an increase of almost 25% year to date (see graph below). The company also paid €0.75 ($1.04) in dividends this year, a 3.00% yield based on Friday's closing share price.

PHG Chart

PHG data by YCharts

To put Philips' share price into perspective, I compared the company's valuation with its competitors General Electric and Siemens. The data is presented in the table below. It seems that Philips is more expensive than Siemens and equally valued to General Electric. Philips' Forward P/E ratio is 15.70, compared to General Electrics' 15.40 and Siemens' 12.50. On the other hand, Philips pays an attractive dividend of 3.00% per year. The dividend yield is higher than General Electric's (yield: 2.80%) and Siemens' dividend (yield: 2.30%).

Philips will probably report the highest increase in earnings per share compared to this year, according to the analyst estimates. This makes sense, because Philips is the most innovative company of the three. The new products will support revenue growth and improve EBITA margin for the upcoming years. Therefore, Philips should be valued with a larger premium compared to its competitors.

PHGGESI
Share price$33.92$26.84$128.34
EPS '14$2.14$1.74$12.28
Change in EPS20.0%6.0%12.2%
Forward P/E*15.7015.4012.50
Dividend yield3.00%2.80%2.30%

*According to the Yahoo! Finance analysts survey

Conclusion

Philips is an attractive long-term stock for investors. The company proved that it is in more innovative than the competitors. This is a key advantage in the industry. I expect that the healthcare business will focus more on efficiency and digitization in the future. Philips is in a great position to serve the customer needs. This justifies a premium valuation over its competitors General Electric and Siemens.

Further, I expect that the introduction of the Vereos PET/CT scanner will have a positive impact on Philips' earnings next year. The Vereos PET/CT scanner is the first and only digital scanner in the world. This should enable Philips to negotiate several attractive long-term contracts. This will support the company's EBITA margin and financial performance.

I am positive that Philips has a strong growth potential. My statement is supported by the fact that the earnings per share is likely to increase by 20% next year. This is a higher growth rate than General Electric (6%) and Siemens (12.2%). Philips has also an attractive dividend yield of 3.00%. All of the arguments above contribute to my conclusion that Philips is a strong buy for long-term investors.

Additional risks

In this article, I refer to Philips' corporate website and several statements made by the CEO Van Houten. Although I do not have any clues that these statements are incorrect, there is a risks that Philips does not deliver the expected results. Further, Philips' competitors could introduce a similar (or even better) scanner in the near future. Such an introduction would be a major threat for Philips and it could change the assumptions I made in this article dramatically.

Source: World's First Digital CT Scanner Puts Philips Ahead Of Competition