Royal Philips (PHG, Financial)(XAMS:PHIA, Financial), the $29.3 billion Netherlands-based company, reported its fourth quarter and fiscal 2016 annual results in January. Koninklijke Philips (Royal Philips Electronics of the Netherlands)Â registered 1.12% sales growth to 24.5 billion euros ($25.991 billion) and a whopping 124.5% profit growth to $1.49 billion, a 5.9% profit margin compared to 2.7% in fiscal year 2015.
As observed, Royal Philips recorded lower cost of sales and general and administrative expenses, which helped improve margins. Further, discontinued operations income grew 70% to 416 million euros.
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“Our HealthTech portfolio‘s performance in the fourth quarter of 2016 demonstrates our strategic focus is delivering results. I am pleased with the 5% comparable sales growth and 190-basis-point improvement in the Adjusted EBITA margin to 15.3%, with growth and margin improvements in all segments of our HealthTech portfolio. For the full year, comparable sales growth of the HealthTech portfolio was also 5%, while the Adjusted EBITA margin showed continued improvement.
“For the Group, comparable sales growth amounted to 3% in the fourth quarter, and operational improvements led to a 190-basis-point increase in the Adjusted EBITA margin.
“Overall, 2016 was a defining year in which we successfully executed on our major strategic initiatives in the transformation of Philips into a focused leader in health technology, including the successful listing of Philips Lighting and securing a good future for the combined Lumileds and Automotive businesses. Operationally, we achieved significant improvements as we delivered 3% comparable sales growth for the year, an Adjusted EBITA margin increase of 130 basis points and an operating cash flow of 1.9 billion euros for the Philips Group.
“Our strong solutions capabilities resulted in a significant expansion of our long-term strategic partnerships, as we entered into 15 new multiyear contracts with an aggregate value of approximately 900 million euros. I see many more opportunities for Philips to grow by leveraging our deep clinical and consumer insights to deliver innovative health care solutions to our customers. Philips’ transformation into a global leader in health technology is acknowledged by FTSE Group’s Industry Classification Benchmark’s recent reclassification of our share to the Health Care industry.
“Our products and related services are subject to various regulations and standards. We are committed to quality and over the last years we have made investments to enable significant progress in this area. We are currently in discussions on a civil matter with the U.S. Department of Justice representing the U.S. Food and Drug Administration, arising from past inspections in and before 2015, focusing primarily on our external defibrillator business in the U.S. While discussions have not yet concluded, we anticipate a meaningful impact on the operations of this business.
“Despite this matter and elevated uncertainty in the markets in which we operate, we will continue to improve our underlying performance and target to deliver 4% to 6% comparable sales growth and, on average, a 100-basis-point improvement in Adjusted EBITA per year for the next three to four years.” –”‹”‹Â Frans van Houten, CEO
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Valuations
Koninklijke Philips traded fairly compared to its peers. According to GuruFocus data, the company had trailing price-earnings (P/E) ratio of 19 times vs. industry median 22.9 times, price-book (P/B) value of 2.2 times vs. industry median 1.9 times and price-sales (P/S) ratio of 1.14 times vs. industry median 1.2 times.
Royal Philips also had trailing dividend yield of 2.8% with 73% payout ratio.
Average fiscal 2017 sales and earnings-per-share multiples indicated 1.09 times and 16.9 times.
Total returns
Royal Philips underperformed the broader Standard & Poor's 500 index this year providing 3.96% total gains compared to the latter’s 5.9%. In the past five years, however, the company outperformed the index by about 50 basis points with 13.9% total return.
Koninklijke Philips N.V.
Koninklijke Philips was founded in Eindhoven, Netherlands, in 1891 by Gerard Philips and his father Frederik.
The company is a Dutch technology company headquartered in Amsterdam with primary divisions focused in the areas of electronics, health care and lighting.
In 2016, Royal Philips derived 34% or 8.4 billion euros of its sales from growth geographies**, another 34% from North America, 24% from Western Europe and 8% from other mature markets.
**Growth geographies are the developing geographies comprising of Asia Pacific (excluding Japan, South Korea, Australia and New Zealand), Latin America, Central & Eastern Europe, the Middle East (excluding Israel) and Africa.
(Annual Report)
In 2016, Philips had the following reportable segments: Personal Health businesses, Diagnosis & Treatment businesses, Connected Care & Health Informatics businesses and Lighting.
(Annual Report)
Personal Health
Personal Health has four segments: health and wellness, personal care, domestic appliances and sleep and respiratory care.
Health and wellness handles mother and child care, oral health care and pain relief product offerings; personal care takes care of male grooming and beauty businesses; domestic appliances cover kitchen appliances, coffee, air, garment care and floor care; and sleep and respiratory care business handles sleep, respiratory care and respiratory drug delivery.
In 2016, Personal Health sales grew 5.2% to 7.1 billion euros or 29% – largest sales generator –Â of total company sales. The division also delivered an EBITA* margin of 15.4%, highest margin among other divisions, compared to 13.1% in 2015.
*EBITA represents income from operations before amortization and impairment on intangible assets (excluding software and capitalized development expenses).
(Annual Report)
Diagnosis & Treatment
Diagnosis & Treatment division has the following areas of business: diagnostic imaging, image-guided therapy and ultrasound.
Diagnostic imaging covers magnetic resonance imaging, computed tomography, X-rays and the like. Image-guided therapy, meanwhile, includes interventional X-ray systems, encompassing cardiology, radiology and surgery among other services. Ultrasound imaging products serve obstetrics/gynecology, and point-of-care applications, including enabling of advanced diagnostics and intervention.
In 2016, Diagnosis & Treatment sales grew 3.1% to 6.69 billion euros or 27.3% of total company sales and delivered an EBITA margin of 8.9% compared to 5.8% the year prior.
(Annual Report)
Connected Care & Health Informatics
Connected Care & Health Informatics segment has three segments: patient care and monitoring solutions, health care informatics, solutions and services and population health management.
In 2016, sales in Connected Care & Health Informatics grew 4.5% to 3.16 billion euros or 12.9% of total sales and generated an EBITA margin of 10.2% vs. 7.5% in 2015.
(Annual Report)
Lighting
According to filings, Philips Lighting is a global market leader with recognized expertise in the development, manufacture and application of innovative, energy-efficient lighting products, systems and services that improve people's lives and has been in the business for over the past 125 years.
In 2016, Lighting sales fell 4.6% to 7.1 billion euros or 28.9% of total company sales and delivered an EBITA margin of 7.6% compared to 5.9% in 2015.
***Other segments such as HealthTech Other and Legacy were not discussed here, but can be read in Royal Philips’ Annual Report pages 43 and 50.
Sales and net income
(Annual Report)
In the past three years, averages sales and profit growth and margin were 1.7%, 7.4% and 3.5%.
Cash, debt and book value
As of December, Royal Philips had 2.33 billion euros in cash and cash equivalents and 5.6 billion euros in total debt with a debt-equity ratio of 0.44 times vs. 0.49 times the same period last year; 38.5% of Royal Philips’ 32.3 billion euros in assets were labeled as goodwill and intangibles having had a book value of 12.6 billion euros vs. 11.7 billion euros last year.
Cash flow
In 2016, Royal Philips grew its cash flow from operations by 63% to 1.9 billion euros. As observed, significant increase in cash flow came from working capital as a result of increase in accounts payable, accrued and other current liabilities.
Capital expenditures including intangible asset purchases and proceeds from sales in property, plant and equipment were 831 million euros leaving Royal Philips with 1.07 billion euros in free cash flow compared to 325 million euros.
(Annual Report)
Royal Philips allocated 80% or 856 million euros of free cash flow in shareholder payouts –Â dividends and share repurchases. The payouts shown in the chart above also took into account any proceeds from share issuance by the company.
(Annual Report)
Royal Philips also received a good amount of cash flow –Â 825 million euros –Â from its IPO of Philips Lighting (LIGHT, Financial) net of costs associated last fiscal year. The company also was a net debt payer with 377 million euros being allocated net of any debt issuance.
As of Feb. 8, Royal Philips had 55.18% stake on Philips Lighting down from 71.225%.
Conclusion
Royal Philips exhibited growth in all of its major divisions. The company also recorded higher overall margins compared to the year prior.
In addition, Royal Philips received an 800 million euro cash flow boost from its recent IPO activity whereby the company still retained majority ownership of Philips Lighting.
Nonetheless, the company carried a good amount of blue sky elements –Â goodwill and intangibles –Â in its balance sheet but with acceptable yet reduced leveraged state.
Royal Philips also exhibited much generosity to its shareholder payouts if not for the added payables accrued in its recent fiscal year to cover it.
Last December, Morgan Stanley downgraded its rating on Philips to equal-weight from overweight. An analyst that covers the company had a price target of $35.77 per share or a 12.4% upside from the price of $31.81 per share.
Using three-year averages for sales multiple and growth rate and applying a 20% margin would indicate a value of 32.8 billion euros or 17.8% upside from today’s market capitalization of 27.8 billion euros.
In summary, Royal Philips is a buy with $35 per share target price per ADR.
Disclosure: I do not have shares in any of the companies mentioned.
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