4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

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Philips: A Massive Upside, I Say 'Buy'

Apr. 13, 2023 9:14 AM ET | Koninklijke Philips N.V. (PHG) | 30 Comments | 17 Likes

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Investing Group Leader

Summary
I last wrote about Philips about a year ago, calling it a "Buy", and my stake has
underperformed for the past 10 months.

While there are risks in the business, I believe there to be more of an upside than a
further downside in the company.

I continue to view Philips as a "Buy" - but expect the company's reversal to take some
time, but with a potential upside of triple digits.

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HJBC

Dear readers/subscribers,

I reviewed Philips (NYSE:PHG) about a year ago, with a positive stance. Since that time,
the company has declined in the low double digits in terms of percent, which isn't the best
result that I expect from a conservative, potential class leader like Philips. This article
serves as a bit of an autopsy, looking at what we can expect from the company going
forward at this lower valuation, but also why the company might have underperformed since
my last article.

After all, we don't want underperforming companies - and I should, and will be able to tell
you what happened here that wasn't in my original expectation for this company.

Updating the thesis on Philips - what we can expect from the

company

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

Philips has seen a massive decline over the last 1-2 years. When I wrote my last? article, I
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assumed that the entry price I managed to get for the company was good enough - but the
company kept declining. To say that there are things "wrong" with the company is going a
step too far. To say that there are challenges with the company, is a different thing entirely,
and that much is true.

Historically speaking, Philips was once one of the largest electronic businesses - but after
significant restructuring, what remains is essentially a Medtech, personal and connected
care business. What was once a huge conglomerate on the size of Siemens
(OTCPK:SIEGY) or similar businesses, has now become a Healthtech business.

This is neither small nor uninteresting in scope because we're talking a triple-digit market in
terms of billions, where Philips is one of the most recognizable names on the planet. The
company already has a dominant market position in attractive legacy markets, such as
Europe and NA, and these geographies continue to generate significant sales.

Looking at the company's share price development, you might think that Philips has
somehow seen significant sales declines. After all, surely some sales declines must be part
of the reason why the company is down double digits - but this is not really the case.

Philips, as a whole and on a broad perspective, in the latest quarter, saw sales growth of
3.4% YoY, with a continued adjusted EBITDA margin of over 16%, at 16.4%.

The company also signed new strategic partnerships and saw highlights in all three
business segments.

PHG IR (PHG IR)

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

To say that customers are not interested in Philips or the products the company ?offers
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would be false. Aside from sales increase, the order book is also filling up. In 4Q20, the
company's order book filled around 55% of Philips NTM Equipment sales. Today, that
number is 70%. This is due to a better sales mix, and higher volumes, in imaging, therapy
products, and monitoring products.

The company has, unlike many of its peers, had contract structures that allow for order
cancellations in cases of margin crunch. So instead of having to finish and ship unprofitable
orders, we've seen Philip simply being able to cancel a whole host of low-margin orders that
the company wasn't pleased with. Despite with, the company is seeing a 30% more well-
filled order book compared to 2 years back. So volumes are not the issue.

Instead, the issues we can see are related to company profitability and margins, which may
not be all that surprising to some of you following broader industry trends. We have
component and raw material inflation, as well as wage inflation, as well as some negative
FX that is weighing on the margins. Here is a look at the current bridge, which tells us that
Philips is fighting back with efficiencies and pricing, but it's not reaching "all the way".

PHG IR (PHG IR)

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

Challenges do not only come from this but COVID-19 impacts as well as the Russian
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invasion of Ukraine. The company also recorded a non-cash goodwill/R&D impairment of
€1.5B, which has also been relevant in seeing what has happened to the company's share
price.

The company does maintain the €0.85 dividend, to be distributed in the form of shares.

The main problem really is flowing from revenue/volume down to profit, and what's
happening to margins. The compression on the profitability side means that Philips has
gone from being average or above-average in the sector, to clearly below average in every
single relevant profitability measurement, both to the sector and to its own history. While
such a development should without a doubt be "punished" in the form of a lower multiple,
what has happened to Philips is excessive.

Philips has a profitability and fundamental issues, and by issues I mean that the metrics are
not as "great" as some of its historical numbers or peers are. Philips is, as of early 2023, a
very below-average company in its sector in these respects (Source: GuruFocus), and the
sector I'm talking about is MedTech/Healthtech - which can be worrying because I do try to
focus on getting above-average companies in quality when I invest.

On the positive side, we have superb dividend yield levels and valuations, to the point
where some are justifiably asking if this company has become, or is a "value trap."

I do not believe it is. I believe the company is currently in a troubling situation, but I also
believe the company is perfectly capable, in time, of turning this around. Philips is hardly
alone in seeing margin compression/profitability problems in this environment. We can't look
too closely at the historicals, because the company's segments and structures have
changed.

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

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PHG net/revenue (PHG net/revenue)

It's too early to say if this negative trend is going to keep going, but I want to clearly state
that this is not the expectation from analysts following Philips. Here is what we're seeing for
the company in the next few years in terms of forecasts.

PHG EBITDA forecasts (TIKR.com)

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

This puts some requirements on Philips in terms of achieving goals - and we are? coming out
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of a multi-year decline from 2019-2020 - so in a way, it's not surprising to see how the share
price has moved. Given that no material EBITDA or earnings improvement is expected for
2023, we can probably "BUY" Philips at a cheap price for the foreseeable future.

Expectations from Philips itself are a careful, gradual improvement over the year of 2023,
going into 2024. It's going to be a slow process, driven by earnings recovery, improvements
in working capital, and the like. The external environment is unlikely to significantly change.
The company is further weighted down by restructuring costs, M&A costs, and other one-off
effects.

The company's segments are attractive - and Philips has key segments where they are
actually already market-leading.

PHG IR (PHG IR)

I also want to "hammer home" how much of a market leader this company actually is, in
most of its relevant segments.

PHG IR (PHG IR)

So, despite everything that's going on in the macro and in the company's current trends,
with the share price at multi-year lows, I'm not really worried about Philips underperforming.
It's a company where I want to keep looking at margin development. Perhaps I'm a bit
laissez-faire about this business due to its size and history. It's an easy mode to "get into"
with an older company like this.

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

For now, I'll be keeping an eye on margin development - there's a lot to like in terms of this
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for the next few years, and we'll want to make sure that these upsides materialize.

Philips Valuation - immensely attractive and a superb upside

Philips has seen an extremely choppy development. Just look at the latest 18-20 years.

Philips Valuation (F.A.S.T. Graphs)

Not the greatest trend we could see in some of the businesses we cover. However,
generally speaking, we would have been potentially profitable if we invested when the
company troughed (provided you recognize undervaluation and sell-off when this time
comes).

For my DCF model for Philips, which is admittedly only of limited use given the company's
volatility, I factor in a single-digit organic sales growth in the next 10 years, driven by
momentum in the company's core segments and incremental, GDP-driven demand growth
in the personal care segment. Pressures in the margins will eventually abate, and things will
go "up" again - those are my assumptions.

I've also modeled for a slightly higher margin in the end years, with EBITDA growth of
around 4% (no higher due to uncertainties related to business challenges and potential
downsides).

The biggest change in my model is the WACC increase and the discount rate, now in the
double digits. With the aforementioned estimates, we're at over $30/share. Even with an
essentially 0-1% growth rate, the company's DCF-implied EV/Share is still above $22/share.

From an analyst forecast perspective, PHG is valued at a range of $17-$28, with an

average of around $21/share. This still implies an upside. However, most analysts are fairly
tepid on the company, calling it a "HOLD", not a "BUY" here. The impression I get is that
investors want to wait to see if the company troughs further, and this is not something I think
is a crazy notion.

However, the upside for the company is significant, as I see it - at least in the long term. I
would rather own a conglomerate such as this one, instead of a risky growth play, as some
investors are targeting it as their capital investments.

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Philips Upside (F.A.S.T. Graphs)

Remember - Philips is BBB+ from S&P Global, the company is a double-digit 20% RoR
annual investment even if you only forecast at 15x P/E, despite the high 3-year growth rate.
Combining this with a dividend yield of almost 5%, I believe this makes for a not-
unattractive play at all - even if Philips has actually been lower in price than what we're
seeing right now.

Based on this, I want to present the following picture on Philips. The company is expecting
sales growth and margin normalization. There are challenges, and the company is not
currently a sector leader or a market leader - but has some of the most solid positions in the
market in its sectors. This in itself is an argument for investment in Philips.

I wouldn't expect massive outperformance in 2023. I expect it will take until 2024 and 2025
until we see a real reversal, at which point the share price should follow suit. That is my
current expectation.

In my last article, I called for a share PT of $30/share. I'm impairing this slightly due to the
margin challenges which have been higher than I expected, and may persist for some time -
so I'm lowering it to $28/share. But there is still a significant upside here.

This forms the basis of my current thesis for the company.

Thesis

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

Philips is a good investment here - that's what I believe. Following this massive price
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crash from 2020 to 2022/23, I do believe that we have enough upside even to a 15X
P/E, to consider an investment here to be worth it. The upside to this 15x P/E is as
high as 20% per year here, based on current growth estimates.

I believe the company's fundamental safety coupled with its market position makes up
for the worries in margins and somewhat impacted financial position. I do say that
there are more positives than negatives here.

My PT for the company is now $28/share, and I'm at a "BUY".

Remember, I'm all about:

1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly

massive - companies at a discount, allowing them to normalize over time and harvesting
capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest
gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back
down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified
in #1.

Here are my criteria and how the company fulfills them (italicized).

This company is overall qualitative.

This company is fundamentally safe/conservative & well-run.

This company pays a well-covered dividend.

This company is currently cheap.

This company has a realistic upside based on earnings growth or multiple

expansion/reversion.

The company fulfills every single one of my upsides here, making it a "BUY".

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4/25/23, 7:42 PM Philips _ A Massive Upside, I Say 'Buy' (NYSE _ PHG) _ Seeking Alpha

The company discussed in this article is only one potential investment in the sector.
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This article was written by

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of PHG either through stock ownership, options, or other
derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking
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