The New Philips: Sustainable Growth?

Summary

• Philips has transformed itself into a healthcare technology company after spinning off Philips Lighting
• The company has been on an acquisition spree focused on bolstering its three main "HealthTech" businesses
• With the spike in 2016 EBIT, is now the right time to invest?

The New Philips: Sustainable Growth?

Koninklijke Philips N.V. (NYSE: PHG) is an international health technology company based in Amsterdam, Netherlands that offers both consumer and clinical enterprise products/solutions. Long a bloated company with over 100,000 employees worldwide, Philips shed its Lighting business in 2016 to focus on its HealthTech portfolio which consists of the businesses listed below.

(All images sourced from Philips' 2016 Annual Report)

Philips’ new focus on its HealthTech offerings has proven to be a wise decision; HealthTech sales grew 5% on a comparable* basis and EBIT margins nearly doubled at 7.7% of sales in 2016 versus 4.1% of sales in 2015. Over EUR 600 million of EBIT in 2016 is attributed to lower procurement costs and higher productivity.

Despite pleasing margins post-restructuring, doubts still linger: will Philips be able to achieve sustainable sales growth? Lowering costs to increase EBIT only works for so long. Thus, answering this question requires a closer look at the three main HealthTech businesses.

Personal Health consists of the following segments:

• Health & Wellness
• Personal Care
• Domestic Appliances
• Sleep & Respiratory Care

Comparable sales for this business grew at a respectable 7% year-on-year. The Health & Wellness segment led the way with double-digit growth, while the other segments experienced mid-single digit annual growth. In terms of geography, sales grew at a high-single digit pace across Europe, the Middle East, and Turkey–while growing at a mid-single digit pace in North America. The entire Personal Health business has thrived as rising incomes in developing markets drive demand for appliances that were once beyond the means of many. The brand awareness of Philips’ Sonicare and Norelco lines has certainly aided market penetration in developing nations, where Philips can rely on robust sales growth for years to come. Overall, higher margins in Personal Health seem sustainable as both sales and EBIT increase at a healthy rate.

Next, let’s take a look at Diagnosis & Treatment:

• Diagnostic Imaging
• Image-Guided Therapy
• Ultrasound

Comparable sales growth was modest at 4% year-on-year. However, the real promise lies within the Image-Guided Therapy segment, which experienced double-digit growth for the year. With the recent acquisitions of CardioProlific and Spectranetics, Philips is aiming to capitalize on innovative peripheral artery disease treatments like Spectranetics’ “Stellarex,” which is currently awaiting FDA approval. Approval of Stellarex in the US is estimated to generate over EUR 100 million in the first few years (and likely more assuming Philips taps into their expansive distribution system). For the other segments, Diagnostic Imaging had low-single digit growth and Ultrasound was flat for the year. The strongest performing regions were Latin America and China, with double-digit and single-digit growth, respectively. Although sales growth in Diagnosis & Treatment were modest, Image-Guided Therapy is promising as Philips’ main growth generator, which they have acknowledged via their recent acquisition spree. If Spectranetics and CardioProlific are immediately accretive, Image-Guided Therapy will be shareholders’ best bet for driving earnings growth.

Moving on to Connected Care & Health Informatics:

Comparable sales grew 4% year-on-year, with the business finally achieving growth after two previous years of flat comparable sales growth. Connected Care & Health Informatics may be less noteworthy compared to the other businesses, but it represents stability through its appeal to contrasting demographics. In growth regions (where birth rates are typically higher) and mature markets (where elderly care is growing exponentially), enterprise products/solutions that cater to postnatal and geriatric care will be in high demand for the foreseeable future. The segments within Connected Care & Health Informatics may not be growth powerhouses like Image-Guided Therapy, but they will be the backbone of Philips’ HealthTech portfolio, helping smooth potential hiccups during the rapid growth of other segments and businesses.

Philips’ stock price has gained approximately $10 in the past twelve months—hovering around $35/share now—which is impressive for a company whose stock price was stagnant for a number of years. Despite 5% in comparable sales growth and a sharp increase in EBIT year-on-year, Philips cannot rely on cost-cutting to create value for investors indefinitely. They will have to prove that they can sustain long-term comparable sales growth–which will be contingent on the performance of their new acquisitions in the Image-Guided Therapy segment.

If you already own Philips, I recommend holding it. Otherwise, I would avoid buying shares unless the 2017 annual report shows that Philips’ acquisition of both Spectranetics and CardioProlific has resulted in continued double-digit growth for the Image-Guided Therapy segment.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.