Philips Electronics: A Bright Light That Will Shine Again

| About: Koninklijke Philips (PHG)

Royal Philips Electronics NV (NYSE:PHG) of the Netherlands is a diversified health and well-being company, focused on improving people's lives through timely innovations. As a world leader in healthcare, lifestyle and lighting, Philips integrates technologies and design into people-centric solutions, based on fundamental customer insights and the brand promise of "sense and simplicity."

Philips employs about 117,000 employees with sales and services in more than 100 countries worldwide. With sales of EUR 22.3 billion in 2010, the company is a market leader in cardiac care, acute care and home healthcare, energy efficient lighting solutions and new lighting applications, as well as lifestyle products for personal well-being and pleasure with strong leadership positions in male shaving and grooming, portable entertainment and oral healthcare.

First quarter results

In the first quarter 2011, reported revenues were up 6% y-o-y to EUR 5.26bln and normalized revenues up 4%. The operating profit (EBITA) dropped 13% y-o-y to EUR 437mln, leaving the EBITA margin at 8.3%, the lowest level for many quarters and weaker than the first quarter of last year. Management indicated that this was the result of weak margins in all its businesses, specifically due to higher selling expenses and raw material costs. Net profit was down 30% to EUR 138mln as a result of the aforementioned divisional weakness as well as the TV business, which Philips had already flagged as being weak.

Philips did not give a very concrete outlook for the rest of the year, except for that the management plans to do an extensive review of all businesses and increase investments in the second half of this year. As a result, margins are likely to stay under pressure during 2011.

Reading this you would argue that Philips is not a good investment opportunity, but with the arrival of new management, the company could become a bright light that shines again. The new CEO, Frans van Houten has a good reputation, having spent many years at Philips before leading semiconductor producer NXP, which was spun off from Philips under his management in 2006. His track record shows him to be someone who is not afraid of making tough choices, as was necessary at NXP during the recession.

Van Houten will have the task to review, streamline and fine-tune the firm's three core businesses: Healthcare, Consumer Lifestyle and Lighting.

Olivier Piccolin, senior vice president and general manager of Philips' lighting unit for emerging markets, told Dow Jones Newswires in an interview last Tuesday that for China Philips targets double digit growth in both the consumer and business markets. Piccolin said the consumer lighting market in China, where Philips has over 1,000 local rivals, is "extremely fragmented." "We want to claim leadership in that field," he said.

Philips holds a top-three position in all segments of the lighting market in Asia except for consumer lighting. To strengthen its presence in high-growth markets, in early 2009 Philips launched retail lighting stores in China, and is now rolling them out in other markets, such as India, Thailand and Indonesia, he said. Piccolin didn't rule out acquisitions in emerging markets in the lighting segment, without elaborating.

Philips has 270 own-brand stores in Asia and over 1,000 sales areas within larger stores. Piccolin said Philips will increase the number of own-brand stores in Asia to 370 this year, mainly in China, its most important growth market.

Philips committed to emerging markets long ago and has grown steadily in these regions. Revenue growth in emerging markets remains strong (+16% y-o-y last quarter) and now represent 32% of total sales, which is expected to grow to 40% in the coming year. Philips will become less dependent on weak Western markets as its grows in emerging markets.

Despite weak cash flow in the first quarter, Philips has a strong balance sheet with over EUR 4.77bln in cash. It has a strong free cash flow which should improve further with the disinvestment of the TV business. Van Houten has taken action because the TV business has been a source of weakness for Philips for a long time.

Production and sales of TV's will be outsourced to third parties, while Philips remains owner of the patents and technology. This step will remove the low-margin commodity like business from their balance sheet and will free up significant amounts of working capital.

The new management has already taken some steps that will enlighten the true value of the company in the coming years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.