GENERAL ANALYSIS
Company description
Royal Philips NV is a major Dutch manufacturer that was founded by Frederik Philips and his son Gerard in 1891 with the aim of improving the efficiency in production and longevity of lightbulbs. After WWII, however, the company began expanding in multiple markets, starting from the consumer lifestyle industry, where it first launched a record label, and later in the hardware industry (from which the company exited some time later). Among other innovations, Philips is renowned for the VCR and the CD, which the company co-developed with Sony and that still represents one of the most popular and revolutionary recording technologies. Currently, Philips is a diversified company that operates in the technological field, ranging from consumer lifestyle (audio systems, domestic appliances and others), healthcare (diagnostic ECG, clinical informatics, emergency care and resuscitation) and lighting. Philips is a global company, with significant presence in most of the countries of the world; it is listed in two stock markets, NYSE and Euronext Amsterdam, which effectively mirrors its importance at a global level; indeed, by engaging in dual listing, the company is able to enjoy a larger capital base, increase its visibility and liquidity and take advantage of longer trading times (NYSE and Euronext Amsterdam are in different time zones, which allows the company’s stocks to be available for a longer time). However, in the course of 2022, Philips consistently underperformed as highlighted in the annual report released by the company, as one of its healthcare products, namely the Respironics, presented serious malfunctions, leading to the recollection of millions of products and a settlement agreement to compensate customers affected. As a consequence, the company concluded 2022 with a need to rebuild its image and reputation as a trustworthy company, especially in the healthcare industry. As of 23 October 2023, the company reported a 4% drop in share prices, as continuing falling orders seem not to be offset by rosier performances (from Reuters.com).
FINANCIAL ANALYSIS
Introduction
In this part of the analysis we will provide a thorough examination of Philips’ financials and performance measures. In this way it will be possible to evaluate the company’s performance so far and in the last years, as well as gain relevant insights on its prospects and investments potential.
Liquidity
Liquidity refers to the ability of an asset to be readily converted into cash for meeting immediate financial obligations or debts. The most common measures used for assessing liquidity are the current ratio, quick ratio, and cash ratio. Generally, a ratio greater than one is regarded as favorable. The current ratio evaluates a company's current assets (those that can be turned into cash within a year). The quick ratio is determined by summing cash and cash equivalents, accounts receivable, and short-term investments, as only more liquid accounts are kept in the calculation, and then dividing by current liabilities. Finally, the cash ratio is calculated by dividing the total of cash and cash equivalents by current liabilities, primarily indicating a company's ability to settle short-term debts with available cash.
By analyzing Philips’ liquidity ratios it is immediately possible to notice that while the current ratio is well above one for the whole period, which signals an ability by the company to meet its current obligations, this is not true either for the quick ratio or for the cash ratio. In fact, for all of the 4 years analyzed neither of the two measures reached the desired threshold; such results highlight Philips’ difficulty in achieving satisfying results when it comes to an ability to bear short-term debt.
Going deeper into the analysis, however, it should also be highlighted that the company registered e decrease in all the ratios starting from 2020, which, again, signals the difficult moments that Philips is going through. In particular, it should be noted that the Cash Ratio from 2022 is particularly low (0.1477), and such a worrying scenario should be addressed by the company.
Profitability
In order to assess the profitability of Philips, we will analyze the main financial indicators: Return on Equity (ROE), Return on Invested Capital (ROIC) and Net Profit Margin. After this analysis, it will then be possible to define the company's profitability in recent years.
Return on Equity (ROE): it is the indicator that measures the return generated by the company’s equity, and therefore indicates the company's ability to use the resources invested by shareholders.
In the last four years Philips has recorded a slight constant increase in ROE between 2019 and 2022 with a peak reached in 2021 (since the company is active in the healthcare field it makes sense that it achieved great results both in 2020 and 2021, as the pandemic increased the demand for products in the industry). However, it concluded the year 2022 with a negative ROE of -12.14%, and since then the percentage of Return on Equity has continued to drop significantly until it reached the value of -27.60% in the last registration on 6/30/2023.
This is due to a huge increase in debt and a decrease in EBITDA of 38.91% in 2021 and a further decline of 32.61% in 2022. All these measures continue signaling a difficulty by Philips in the last periods, as highlighted in the previous section (liquidity) and also in the company description.
Return on Invested Capital (ROIC): measures the return generated by the company on its invested capital, showing the company’s ability to allocate its capital efficiently on investments. Philips’ results have a similar behavior to ROE, as the company achieved its best results in 2021 (around 15%), but saw a negative peak in the last financial year (ROIC equal to -7.50%) However, it should be noted that even in the previous years the company always managed to record a positive ROIC, until last year. This stresses, once more, the fact that 2022 was a very dissatisfying year for Philips, that seems to be struggling to recover from it in this year as well (as highlighted by ttm measure which reports once more a negative result).
Net Profit Margin: this measure evaluates a company’s operations’ profitability after the deduction of all expenses, both from operations and financing activities, and taxes. As it is possible to notice from Philips’ results, the company had increasing figures throughout the trimester 2019-2021, reaching its best performance in 2021, with a result equal to 19.35% (achieving an increase of 13% on its 2020 and 2019 performance). Nonetheless, the effects of FY 2022 are visible in this account as well; in fact, Net Profit Margin turned negative (-9.02%) in the year (due to a disappointing result in Net Income).
Stock Valuation
In this financial report, we will perform a stock valuation analysis for Koninklijke Philips N.V. using the Discounted Cash Flow (DCF) model. The DCF model relies on forecasting future cash flows and then summing their present values to determine the company's enterprise value.
At the beginning of the analysis, we calculated the weighted average cost of capital (WACC) using external estimates for market risk premiums, cost of debt (sourced from Professor Aswath Damodaran), risk-free rates, tax rates, and the company's beta. CAPM was hence used to determine Cost of Equity.
To obtain the present value of Philips, we projected its future cash flows; we started by considering revenue growth and conducting regression analyses for capital expenditures, depreciation, amortization, and working capital investments as a percentage of revenues. Revenue forecasts were based on estimates in the Q3 2023 report released by the company (for 2023 sales) and later estimated using the inflation rate. To be more precise, instead of assuming a constant 6% growth, we assumed revenues to approach 2%, which is the EU's target inflation rate. EBIT (earnings before interest and taxes) was also predicted through a regression analysis on revenues (considering a variety of independent variables for regression might have led to excessive errors).
These projected cash flows were then discounted to their present value using the company's WACC of 7.12%.
Subsequently, we calculated the terminal value using two distinct methods: perpetuity growth and EBITDA exit multiple. In the first method, we applied a conservative growth rate of 2.5%, close to the target inflation rate. This approach yielded a stock price of €24.52. In the second method, we used an EBITDA exit multiple of 8x. Although in the last period Philips has greatly dedicated a lot of its resources into the healthcare industry, it is still diversified enough to make it difficult to find directly comparable companies. Hence, it was not possible to fully rely on the measures found. Using this approach, we arrived at a stock price of €2.73.
Given the variance between these values, we decided to compute a weighted average of the two estimates. We assigned a slightly higher weight to the perpetuity growth method (65%) than the Exit Multiple Method (35%), because of the above-mentioned reasons. This resulted in a stock price estimate of €16.89. This estimate aligns with the range published on Yahoo Finance.
Overall, this calculation suggests that Philips is still being affected by the effects of its underperformance from the previous year. While 2023 appeared promising in some aspects, the company still faces significant challenges, which are reflected in its stock price.
Multiples Analysis
Multiples analysis is used to assess the company’s performance and valuation, by comparing it with its direct competitors and the industry.
Are now analyzed Philips’s EV/EBITDA ratio and P/E ratio.
EV/EBITDA ratio: At the end of 2022 Koninklijke Philips's EV/EBITDA ratio is around 8.26; This value indicates that the enterprise value given by investors is 8,26 times the value of EBITDA.
The average ratio of companies operating in the Healthcare Products industry is 19.9, according to Professor Aswath Damodaran of NYU. This means that the company has a lower valuation respect to competitors.
P/E ratio: Analyzing the other value, this is calculated by dividing the stock's current price by its latest earnings per share, and it is useful to show whether a company's stock price is overvalued or undervalued. Philips has registered a P/E ratio of in 2022; this was due to a negative value in the earnings per share, which amounted to -1.82. Always referring to Professor Aswath Damodaran’s studies, the average P/E ratio in the industry is 99.46; this denotes a huge undervaluation of the company compared to others in the industry. However, such a result should be assessed against the scenario described at the beginning of the analysis, meaning that there is fear in the market that Philips might not actually recover from last year’s performance and actually keep witnessing declining orders (especially from China).
Piotroski Score
The Piotroski score is an indicator of the financial strength of a company that is based on the comparison of specific company balance sheet data. The score is between zero and nine, and it reflects nine financial criteria divided into three categories:
Profitability:
- Positive net income
In the first criterion analyzed Philips does not take the point because, despite having concluded with positive net income in previous years, in 2022 it had a negative value on its balance sheet equal to a loss of EUR 1.605 million
- Positive return on assets
The ROA is negative because of the negative net income performed in 2022.
- Positive operating cash flows
The net cash flows from operating activities amounted to an outflow of EUR 173 million in 2022; so it doesn't take the point here either.
- Cash flow from operations being greater than net Income
As evidenced in the sections above Philips takes the first point
Leverage, liquidity, and source of funds:
- Lower amount of long term debt in the current period, compared to the previous year
The amount of long term debt in 2022 is EUR 8.111 million, while in 2021 was EUR 6.933 million. Philips doesn't take the point.
- Higher current ratio this year compared to the previous year
The current ratio of Philips is 1.29 in the 2022 annual report, this ratio had the value of 1,39 in 2021 and because of that the Piotroski score is still 1 out of 9
- The absence of new shares issued in the last year
The company doesn’t take this point because during the year 2022 it issued 889 million shares in the market, while in 2021 the number of shares issued amounted to 884 million
Operating efficiency:
- A higher gross margin compared to the previous year
Although compared to the year 2020 the gross margin decreased from EUR 7.820 million to EUR 7.194 million, this slightly increased compared to the year 2021, in which the value recorded was of EUR 7.168 million. Philips gained the second point in the Piotroski score.
- A higher asset turnover ratio compared to the previous year
The value of the asset turnover ratio in 2022 is higher than the value in 2021, reaching 0.58 this year compared to 0.55 the previous year, referring to the annual report. This last criterion allows Philips to obtain another point and finish with a Piotroski score of 3 out of 9.
We can conclude by saying that in the year 2022 Philips did not demonstrate financial solidity, increasing its debt and ending with huge losses. Its Piotroski score of 3/9 classifies the company as financially weak and implies poor business operation.
Risks
Philips is still in the process of its transformation and will focus on improvement of the financial metrics over the next years.
The risk profile of the company has deteriorated as the diversification reduced by heavily focusing on healthcare. The prospect of an aging population will probably draw new competitor companies into the field of healthcare, resulting in massive investments in health-tech companies.
Despite that, for a dividend investor, the company does not present an alluring investment proposition due to the negative performance of the last year and the low dividend growth.
Because of the risk awareness created by the analysis of the last annual report, it will take some time before investor confidence returns and the stock price shows significant gains.
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