Philips (PHG) is a diversified industrial conglomerate focused in the areas of people's health and well-being. Philips has changed over the past few years from a broad based conglomerate to a diversified industrial group with a focus on consumer, health and personal care. Although its transformation is not complete, the company has now a stronger business model providing a higher level of safety for long-term investors. It currently offers a dividend yield of close to 3%, which is not among the highest in the stock market but has very good growth prospects.
Philips was founded in Eindhoven in 1891 being nowadays one of the largest electronics companies in the world, employing around 122,000 people across more than 100 countries. As a diversified group, Philips has a wide portfolio of categories/business units, which are grouped in business groups primarily on technology or customer needs. The company reports its performance based in three segments: Healthcare, Personal Health and Lighting. Philips' largest segment is healthcare accounting for about one-third of its sales and is also the company's most profitable. Its major competitors include other consumer goods companies, such as General Electric (GE) or Siemens (SI). The company's primarily listing is on the Euronext Amsterdam but is also listed on the New York Stock Exchange through its American Depositary Receipts program. Philips has a market capitalization of $32.8 billion.
After significant restructuring in the last decade it is now focused on three different businesses holding leadership positions on each segment, focused on the "consumer wellness" theme. Each business serves different end-markets, providing therefore a good business diversification. Philips has transformed its portfolio and profitability in the past 10 years. The company has successfully shifted the portfolio away from cyclical business towards leading positions in growth businesses that could deliver higher margins throughout the economic cycle. It started an efficiency plan in 2011 called "Accelerate," being a multi-year programme, which will run through 2017. Its restructuring plan has focused the company on areas where it has competitive advantages, innovation capability and a strong brand, thereby enabling higher organic growth and margins. The result of this transformation has been to create a more stable and reliable business model, laying the foundations for a "buy and hold" investment proposition.
Among Philips' current key attractions is its strong brand image and high exposure to emerging markets, at 36% of sales in 2012 versus about 27% in 2004. It has one off the highest exposures to emerging markets within its industry. Developed markets of Western Europe and North America are responsible for about half of its sales. Over the long term, Philips is exposed to global trends that will increase demand for its products. Among the most important, through its three business segments, Philips is well positioned to benefit from growing and aging populations, rising middle class in emerging markets and ongoing urbanization and globalization. The adoption of LED lighting is also boosting its growth profile and reducing its lighting business sensibility to the economic cycle. On the other hand, Philips sells most of its products through distributors and is thus exposed to the destock/restock inventory cycle, which can have a meaningful impact on its cash flow generation.
Regarding its financial performance, Philips has posted increasing sales since 2009 despite economic weakness in Europe over the past couple of years. In 2012, Philips' sales increased by close to 10% to $33.4 billion. Its organic sales growth was lower at 4.1%, with growth markets being the growth engine posting a 10.1% organic sales growth. Its EBITA amounted to more than $2 billion, or a margin of 6.2%. Its cost reduction program is delivering more reductions than expected, helping to improve margins. So far, savings have been above $1 billion, helping to explain its higher operating margin achieved during the past few months. Philips is expecting about $2.7 billion in savings by 2015 targeting overhead cost reductions. During the first nine months of 2013, Philips' gross margin has improved by more than 3% and its EBITA margin has recovered to about 10%. This improved profitability is also reflected on the company's earnings-per-share [EPS], which should increase considerably in 2013 to $1.84 compared to only $0.34 in 2012. Going forward, Philips' guidance is for 4-6% organic revenue CAGR from 2014 to 2016 and a 2016 EBITA margin target range of 11% to 12%.
Regarding its dividend, Philips' history is good given that its dividend has been relatively stable over the past five years, with only one increase in 2011. Its last dividend payment was €0.75 ($1.03) per share, paid annually like many European companies. Furthermore, Philips has performed a €2 billion ($2.7 billion) share buyback program over the past couple of years, increasing shareholder remuneration considerably. The company seems committed to maintain its shareholder remuneration policy, given that it has recently announced a new €1.5 billion ($2 billion) share buyback program over the next two to three years. Its dividend payout ratio should be 56% in 2013, assuming an unchanged dividend per share. Philips' payout target is between 40% and 50% of continuing net income, so it should be able to increase its dividend over the next few years.
The company's dividend and share buyback program is supported by its good cash flow generation and very strong balance sheet. In 2012, Philips' cash flow from operating activities amounted to almost $3 billion, which was more than enough to finance capital expenditures, dividend payments and share repurchases. The company's net debt was unchanged during 2012 at only about $950 million, representing a very small net debt-to-EBITDA ratio of 0.2x.
Philips is undergoing a turnaround phase focusing on areas where it has long-term competitive advantages, leading to improved financial results and higher business margins. Its cost reduction program is showing good progress, which together with Europe's economic recovery should boost its profits over the next few years. Over the long term, its high exposure to emerging markets provide a solid growth base, making Philips an attractive income investment.