Philips Now Has More Problems Than Just The DreamStation Recall

 

Next to "it's different this time", "it likely won't get any worse" (or "how much worse can it get?") are probably the most dangerous words in investing, and the experience at Philips (PHG) shows the dangers of trying to pick a bottom when there is a significant negative, hard-to-quantify event - a major product recall in this case - underway.

Philips shares have lost another 30% of their value since my last update, and not only has the DreamStation 1 recall situation gotten arguably worse, the company has also underperformed on its ongoing fundamentals. That dredges up a lot of unpleasant memories related to past execution missteps and inadequacies and raises legitimate questions about whether Philips really has changed for the good.

Even with negative revisions to my margin estimates and discount rate (to account for greater risk/uncertainty), the shares do still screen as undervalued, but it wouldn't be hard to argue that this is a "cheap for a reason" case with not much to drive substantially better near-term sentiment.

 

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Philips Now Has More Problems Than Just The DreamStation Recall

Philips's DreamStation Nightmare Could Be A Longer-Term Opportunity

 

“Buy the dips” may be good advice, but it’s often tough to follow because meaningful pullbacks don’t usually happen without a reason, and that proximate cause is often scary in the short term. Such is the case with Philips (PHG) and its recall (and future litigation) of the DreamStation 1 sleep apnea machine. While there are billions in potential liability costs in play, it looks as though the market has overreacted to what should prove to be a manageable situation for the company.

Given that the market reaction would already seem to factor in a more-than-worst case scenario, this is a name for investors to consider, but only if they can be patient during the ups and downs of what is likely to be a multiyear resolution process. Long-term revenue and FCF growth of 3% and 6% can support a meaningfully higher price, but Philips management is likely back to square one when it comes to rebuilding its credibility with analysts and institutional investors.

 

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Philips's DreamStation Nightmare Could Be A Longer-Term Opportunity

Philips Leveraged To Post-COVID Normalization And Self-Improvement

 

It's been a little quiet of late for Philips (PHG), with the shares almost flat since my last update, but still outperforming the broader med-tech sector by a modest amount. The sale of the domestic appliances business didn't generate that much excitement, even though management got a good price and there is now certainty for this item on the to-do list.

With the successful sale of the domestic appliance business, normalizing elective procedures and hospital capex in 2021, and further self-help in the years to come, I continue to believe these shares are undervalued.

 

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Philips Leveraged To Post-COVID Normalization And Self-Improvement

Philips Undervalued Ahead Of Normalizing Procedures And Telehealth Growth

Helped in part by the company’s significant ventilator and monitoring assets, Philips (PHG) has performed better than many peers through the pandemic, as sales of those types of medical equipment have offset weaker “big iron” imaging system sales and lower procedure-driven revenue. Looking ahead, the eventual run-off of the pandemic will create tougher comps, but procedure and imaging sales should grow, and Philips is well-leveraged to long-term trends in telehealth.

Philips shares are up another 15% or so from the time of my last update, outperforming the broader med-tech space and peers like Medtronic (MDT), though Siemens Healthineers (OTCPK:SMMNY) has done even better over that short period of time. I still believe these shares offer worthwhile upside, with longer-term efforts to grow telehealth and boost operating margins offering some upside to growth rates.

 

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Philips Undervalued Ahead Of Normalizing Procedures And Telehealth Growth

Philips Still Reaping A COVID-19 Tailwind, As Procedure Counts Recover

Dutch med-tech conglomerate Philips (NYSE:PHG) is an interesting position right now. The company has reaped some benefit from the COVID-19 pandemic in its ventilator and monitoring business, and the company’s image-guided therapies business should be levered to the profitable elective procedure growth that hospitals want to encourage, but imaging is going to be under pressure a little while longer on strained hospital capex budgets. At the same time, the company is exiting a multiyear period of impressive gross margin improvement, but still has work to do on SG&A and R&D.

Even with concerns about an overhang in the imaging business, I went positive on Philips in early September, and the shares have risen about 10% since then, beating the market and the med-tech space over that small period. I’m still pretty bullish on these shares; I’d like to see more leverage to the sorts of elective procedures that hospitals are keen to grow, but I also do see meaningful operating margin improvement potential that doesn’t seem to be in the share price.

 

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Philips Still Reaping A COVID-19 Tailwind, As Procedure Counts Recover

A Busy Week For Philips, But Underperformance Creates Some Opportunity

This has been one of those "interesting" weeks for Philips (PHG), as increased scrutiny and criticism over the company's ventilator supply contract with the U.S. Department of Health and Human Services ultimately led to the cancellation of that contract, with less than 30% of the ventilators delivered. At the same time, the company made an acquisition in its image-guided therapeutics business that didn't get much attention but could drive some meaningful revenue down the road.

Philips shares are down about 10% since my last update (when I was basically neutral on the shares), and the shares have underperformed its medical device peers by over 15% over the past month. With that underperformance, these shares are worth a closer look as procedure counts continue to improve in the second half of the year.

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A Busy Week For Philips, But Underperformance Creates Some Opportunity

Philips Has A Big Opportunity To Show Its Ability To Execute

Diversified healthcare companies don’t really provide many clean reads on the COVID-19 crisis. Philips (PHG) is a good case in point, as the company’s Image-Guided Therapy business is likely to see weak procedure counts until at least the second half of the year, and the COVID-19 crisis could drive lower capital equipment spending in Imaging. On the other hand, Philips is going to see significant revenue growth in its Monitoring and Ventilator businesses, and if management can execute on this opportunity (in terms of margin leverage), the upside is meaningful.

I don’t really like “Big Iron” in healthcare (a colloquialism covering large-scale capital equipment), and that is more than one-third of Philips’ business. On the other hand, expectations are not demanding, and Philips could still have some upside if it can execute well on its order book.

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Philips Has A Big Opportunity To Show Its Ability To Execute

Can Reduced Expectations And A New Product Rebuild Inogen's Premium?

Hyper-growth med-tech valuation exists in its own parallel dimension, and it’s a place where I rarely venture with my own money. To that end, I wasn’t excited about the premium the market was giving Inogen (INGN) a year ago and I haven’t seen much reason to write about it since then. In that time, though, the shares shot up more than 75% before starting a fall that has seen the shares lose more than 80% of their value.

I didn’t think the shares deserved to be trading at $160+ back in May of 2018, let alone nearly $290, but I also don’t think the mid-$60’s is fair now. While I’m not crazy about Inogen’s direct-to-consumer model, the reality is that working through home/direct medical equipment vendors isn’t any easier and there’s a definite market for portable oxygen concentrators given the limitations of air tanks. I do believe competitors like Philips (PHG) and ResMed (RMD) constitute a longer-term threat, but I also believe Inogen can lose some market share and still generate long-term revenue growth in the double-digits and high-teens FCF margins. It’s going to take time for Inogen to win back investor interest, but a new product launch and improved rep productivity should drive improved results from here.

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Can Reduced Expectations And A New Product Rebuild Inogen's Premium?

Inogen Continues To Generate Some Of The Best Growth In Med-Tech

Trying to figure out a fair value for a med-tech company in its high-growth phase is a really good way to look stupid, and so it is for me with Inogen (INGN). While I really like the growth story at this leading developer and manufacturer of portable oxygen concentrators, I thought valuation was already pretty generous based upon what investors typically pay for this sort of growth.

That was less than a month ago, and the shares are up another 25% as Inogen delivered a blowout first quarter and offered what looked like pretty conservative guidance for the remainder of the year. With Inogen largely setting the pace in terms of product features/capabilities and not much serious competition looming in the short term, I can understand why investors continue to bid up this fast-growing med-tech player.

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Inogen Continues To Generate Some Of The Best Growth In Med-Tech

Inogen May Only Be Getting Started

A mid-cap med-tech company with 20%-plus revenue growth, profitable operations, positive free cash flow, and a large addressable market is going to get noticed, and so it has been for Inogen (INGN) - the shares have risen more than 70% in the past year and trounced the likes of ResMed (RMD) and Invacare (NYSE:IVC), not to mention the S&P 500, over the last three years as this company has grabbed more and more share of the growing portable oxygen market.

Although the fundamental growth story is strong, it's hard to see the appeal outside of growth and momentum as the company trades well above what I consider a reasonable cash flow-based valuation and at over 9x forward revenue. That said, if you are a valuation-insensitive growth investor looking for a momentum story, maybe this is a name to check out.

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Inogen May Only Be Getting Started

Stryker Producing Excellent Results, But Expectations Are High

This year will be the 25th year I've followed med-tech (holy crap I'm old…), and Stryker (SYK) continues to amaze me. Apparently, Stryker never got the memo about "trees not growing to the sky" and the need to settle into a quieter middle age. In addition to pursuing growth-oriented M&A to augment existing businesses and address new markets, Stryker continues to do an excellent job of managing its long-held core businesses.

A business that performs as well as Stryker should command premium valuation, but how much of a premium? High single-digit FCF growth suggests an expected return of around 7% to 8%, and maybe that's not bad expected return/risk balance for a company like Stryker. Still, I believe the expectations are a little too high now, and I'd want a better expected return before buying in - even for one of the best-run companies out there.

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Stryker Producing Excellent Results, But Expectations Are High

Seeking Alpha: Philips Looks To Long-Time Laggard Volcano To Perk Up Its Healthcare Biz

It took a long time, but Volcano (NASDAQ:VOLC) finally found its buyer. Now the question is whether Philips (NYSE:PHG) can generate the growth and profits from Volcano's platform of technologies in intravascular imaging and therapeutics that Volcano's management never could. Investing more resources into image-guided therapeutics is not a bad call on the surface, but Philips must prove that it has moved past its legacy of below-average (if not outright poor) deal integration and must prove that the potential synergies between these two cath lab companies can win out over competitive threats from the likes of Boston Scientific (NYSE:BSX) and St. Jude Medical (NYSE:STJ).

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Philips Looks To Long-Time Laggard Volcano To Perk Up Its Healthcare Biz

Investopedia: Can LEDs Brighten Investor Portfolios?

Goldman Sachs recently highlighted LED lighting as a top “disruptive” theme over the next decade. While I'm often inclined to believe that these sell-side "theme pieces" are designed more towards generating attention during stretches of slow company news, I have little doubt that the penetration rate of LEDs in the lighting market is going to increase significantly over the next decade. That is going to fuel significant demand for LED-making equipment, LED packaging, and finished lighting fixtures for companies like Aixtron (Nasdaq:AIXG), Cree (Nasdaq:CREE), Philips (NYSE:PHG), and Osram What is less clear to me is the extent to which investors can expect to see huge gains at this point – the “LED revolution” has been long in coming and while there are certainly going to be trading opportunities come and go, the idea of “buy and hold” in this sector seems optimistic at best.

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Investopedia: Expectations, Not Performance, Eclipse Cree

It's pretty rare for a company at the leading edge of an emerging technology to have a smooth growth trajectory, and LED leader Cree (Nasdaq:CREE) has certainly had a few wobbles over the years. That said, Cree has established itself as one of the “Big Five” LED chip companies, one of the three major integrated LED lighting companies, and a leader in patents and technologies. Couple that with a greater than 10-year run of positive free cash flow and it's not hard to see why Cree is a go-to name for growth investors.

That popularity comes with a cost, though. It's exceedingly rare to see a company's stock rise more than 150% in 12 months and still have modest expectations and/or an undemanding valuation attached. Given that margins are a pressing concern with Cree and the company's guidance for the next quarter looked light, it's not too surprising to see the shares indicated down in pre-market trading.

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Seeking Alpha: Mindray's Quarter Won't Settle Diddly

Both bulls and bears can find information in Mindray's (MR) second quarter report to uphold their preexisting biases about the stock. Convinced that that growth is slowing and the company is seeing less margin leverage? There are data to support that. Convinced that Mindray can continue to exploit a huge market for quality value-priced medical equipment while generating good free cash flow? We've got you covered there too.

At a minimum, I'd say Mindray is in that awkward phase where the company is alienating pure med-tech growth investors, but not yet attracting the margin/cash flow-driven value/GARP crowd. Although I think recent ventures into immunoassay and ultrasound could pay off down the road, I'm not as willing to stick my neck out right now for a stock like Mindray.

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Mindray's Quarter Won't Settle Diddly

Investopedia: Siemens Definitely Slimming Down, But Execution Is The Big Unknown

German industrial conglomerate Siemens (NYSE:SI) has gotten a great deal more serious about streamlining its operations around those businesses and markets where management believes they have a long-term edge and appealing growth potential. With that, Nokia Siemens Networks is gone, Osram is about to be spun off, and other businesses like water treatment, baggage handling, and low voltage could be on the way out.

Siemens actually held pretty good share in these businesses, so the streamlining process doesn't really change the fact that Siemens is typically a leader in its chosen businesses. What still has to be proven is whether the company can significantly improve its execution and margins. Relative to many other global industrial conglomerates, Siemens has an unspectacular track record in margins, returns on capital, and free cash flow generation, and management needs to convince the Street that it can do better before the shares will garner a better multiple.

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Seeking Alpha: Red-Hot Novadaq Shows There's Green In Being Green

There aren't a lot of great med-tech growth stories these days, and many of those are already quite expensive. Novadaq Technologies (NVDQ) is hardly cheap at almost 22 times sales, but this company is very early in its product launch life and could see revenue grow from about $25 million over the trailing 12 months to perhaps $1 billion down the road.

With an affordable, safe, easy-to-use diagnostic system that delivers very real benefits in terms of lower complication rates and costs, Novadaq has an impressive opportunity as well as strong partners like LifeCell and Intuitive Surgical (ISRG) to help them realize those opportunities. I think it's relatively easy to argue that Novadaq is worth about $18 per share today, and seeing upside beyond $21 is not too challenging.

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Red-Hot Novadaq Shows There's Green In Being Green

Seeking Alpha: Baby, Baby, Where Has The Love Gone?

Natus Medical (BABY) is a case in point as to why I'm always skeptical around growth stories built on rampant M&A activity, particularly when those growth stories are awarded the sort of multiples that go with the strongest organic growth names in the med-tech space. To that end, while Natus had a career-making run through the first decade of this century, the going has gotten a lot tougher post-2008, during which time Natus has lagged another famous (or infamous) growth-by-acquisition story Integra Lifesciences (IART) and other less-than-stellar performers like Medtronic (MDT).

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Baby, Baby, Where Has The Love Gone?

Investopedia: Recent Financials May Not Be Entirely Fair To Hologic

I have no qualms with those who believe it is the responsibility of the management of public companies to communicate clearly and accurately with investors (and analysts) about the current state of the business and the likely near-term conditions. Likewise, I don't particularly object when the Street punishes those companies that come in short of expectations without having given suitable warning.

So I can understand some of the disappointment with Hologic (Nasdaq:HOLX) these days – the company arguably could have done a better job communicating (and adjusting expectations) in regards to the fall-off in 2D mammography, ThinPrep, and the Chinese business. At the same time, though, I see a lot of what's troubling Hologic as macro issues impacting the sector as a whole. As the company is continuing to execute reasonably well on costs and the Gen-Probe integration, today's share price may be something of an opportunity.

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Investopedia: Hope Seems To Outshine Reality At Acuity Brands

It has been almost two years since I last wrote on Acuity Brands (NYSE:AYI), and in that time the company has seen only the barest recovery in residential and commercial construction, the acquisition of a major competition by a large conglomerate, and the advancement of LED lighting as a more feasible alternative. It is this last item that is likely to be the biggest driver for Acuity, as a switch to more efficient LED lighting could stimulate significant sales. As often seems to be the case with Acuity shares, though, it seems like investors are already well ahead of curve on this name.

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