Koninklijke Philips Electronics N.V.
/ (PHG-NYSE)/ Equity Research / PHG | Page 1
Current Recommendation / NEUTRAL
Prior Recommendation / Outperform
Date of Last Change / 03/20/2013
Current Price (05/03/13) / $28.26
Target Price / $30.00
SUMMARY
We maintain our Neutral recommendation on Phillips with a $30 target price. The company has returned to profitability in the fourth quarter 2012 against a loss in the year-ago quarter, sending earnings estimates higher over the past 30 days. Cost reduction plans and innovative product launches should add to the company’s growth strategy and work in its favor. Further, sales increased 153% on a comparable basis with all sectors performing well. Though the stock is yet to reach pre-recession price levels, it did well in 2010 and plummeted again in 2011. Now, the stock is again back on the recovery path and its growth prospects appear bright with the rising Zacks Consensus Estimate./ Equity Research / PHG | Page 1
SUMMARY DATA
52-Week High / $31.7252-Week Low / $17.32
One-Year Return (%) / 53.67
Beta / 1.45
Average Daily Volume (sh) / 800,688
Shares Outstanding (mil) / 915
Market Capitalization ($mil) / $25,846
Short Interest Ratio (days) / 2.37
Institutional Ownership (%) / 6
Insider Ownership (%) / N/A
Annual Cash Dividend / $0.00
Dividend Yield (%) / 0.00
5-Yr. Historical Growth Rates
Sales (%) / -4.4
Earnings Per Share (%) / -7.6
Dividend (%) / -1.1
P/E using TTM EPS / 19.9
P/E using 2013 Estimate / 15.9
P/E using 2014 Estimate / 13.7
Zacks Rank*: Short Term
1–3 months outlook / 4 - Sell
* Definition / Disclosure on last page
Risk Level * / Below Avg.,
Type of Stock / Large-Value
Industry / Elec Prods-Misc
Zacks Industry Rank * / 220 out of 267
OVERVIEW
Headquartered in Amsterdam, The Netherlands, Koninklijke Philips Electronics N.V. (PHG) is one of the world’s largest electronics companies and the biggest in Europe, with sales of €24.8 billion in the full year 2012, reflecting a 10% nominal increase for the year. The company is divided into four distinct business sectors after the sale of the semiconductor division: Healthcare, Consumer Lifestyle,Lighting and Innovation & Group Services.
Research and development costs increased from EUR 1,610 million in 2011 to EUR 1,810 million in 2012. The year-on-year increase was largely attributable to higher investments in growth and innovation, including an increased focus on new value spaces. As a percentage of sales, research and development costs increased from 7.1% in 2011 to 7.3%.
Philips’ Healthcare segment is the third largest manufacturer of medical diagnostic equipment, which includes X-ray, ultrasound, magnetic resonance, medical information technology (IT), nuclear medicine, patient monitoring, information management and resuscitation products, as well as a comprehensive range of services.
Philips’ Lifestyle segment produces a wide range of products in the areas of shaving and beauty, oral health care, food and beverage and home environmental care. The enhancement of its product offerings has come through continuous technological development.Under this segment, Philips also designs and manufactures products ranging from televisions and DVD players to mobile phones and portable music devices.
The company’s Lighting segment offers products spanning a full range of incandescent and halogen lamps, compact and normal fluorescent lamps, high-intensity gas-discharge and special lamps, LED (light-emitting diode)-based lighting and automotive lamps and accessories.
REASONS TO BUY
The restructuring of Philips’ portfolio of products to better position itself as a more-focused company in the healthcare, lighting and lifestyle markets is in progress with several focused acquisitions and divestments over the past three quarters. Philips announced that it has acquired the assets of InnerCool Therapies Inc., a pioneer in the field of therapeutic hypothermia, which involves the management of a patient’s body temperature.
Phillips implemented a comprehensive performance improvement and change program called Accelerate to realize the value potential and speed up growth. In addition, the company has launched key initiatives to implement the Phillips Business System, which includes a €500 million cost reduction program that is expected to be accretive to margins from 2013.
Cost reduction plans and innovative product launches should add to the company’s growth strategy and work in its favor. Philips is progressing well with its €800 million cost reduction plan targeting mainly overhead and indirect costs. The company has recently launched new and innovative products including an innovative product for sleep apnea patients and a unique appliance dubbed AirFryer that, aptly, fries using air.
Phillips is all set to benefit from the rapid adoption of LED-based lighting solutions across the globe. In the last reported quarter (4Q2012), LED sales grew 43% year over year and now represent 25% of the total lighting sales. Phillips currently is the market leader for LED-based lighting solutions.
REASONS TO SELL
Philips has made large investments in the reshaping of the Group into a more market-driven company focusing on delivering advanced and easy-to-use products and easy relationships with Philips for its customers. If Philips fails to deliver on its brand promise, its growth opportunities may be hampered, which could have a material adverse effect on Philips’ revenue and income.
Philips has recently completed acquisitions and is expectedto continue to do so in future, exposing it to integration risks in areas such as logistics, regulatory compliance, information technology and finance. Integration difficulties and complexity may adversely impact the realization of an increased contribution from acquisitions. Philips may incur significant acquisition, administrative and other costs in connection with these transactions, including costs related to the integration of acquired businesses.
Emerging markets are becoming increasingly important in the global market. In addition, Asia is an important production, sourcing and design center for Philips. The company faces strong competition to attract the best talent in tight labor markets and intense competition from local companies and other global players for market share in emerging economies.
RECENT NEWS
Bright 1Q Earnings for Phillips Electronics
Koninklijke Phillips Electronics N.V. (PHG) reported a net income of €162 million ($460 million) in the first quarter of 2013, up153.1% year over year. The year-over-year growth was primarily due to 31% higher earnings across all the sectors of the company. In addition, project Accelerate has been a success during the reported quarter.
Excluding the impact of €119 million of net gains related to the Senseo transaction and the sale of the High Tech Campus real estate in the first quarter of 2012, net income in first quarter of 2012 came in at €64 million.
Quarterly Details
For the first quarter of 2013, the company reported revenue growth of 1% to €5.25 billion ($9.3 billion) compared to the prior-year quarter. However, group nominal sales contracted 1%, which included a negative 2% impact of currency and portfolio changes.
Earnings before Interest, Tax and Amortization (EBITA), excluding one-time items, stood at €402 million ($113.4 million) or 7.6% of sales versus 8.5% in the prior-year quarter. However, after adjustments related to the Senseo transaction and the sale of the real estate adjusted EBITA grew €421 million or 8.0% of sales compared to 6.1% of sales in the comparable prior year quarter. Improvements in the EBITA were driven by higher gross margin across all the segments of the company.
Segment Details
Healthcaresales for the quarter were down 1% year over year to €2.1 billion ($3.76 billion), driven by weakness across some of its businesses.Customer services and Home Healthcare solutions reported low single-digit growth and Patient Care & Clinical Informatics sales were flat year over year. In addition, Imaging systems sales also declined in the high single-digits during the quarter.
Geographically, revenues in North America declined 10% year over. Further, sales from Europe and emerging markets also declined7% and 4%, respectively, in the reported quarter.
Orders in the Healthcare segment declined5% year over year in the reported quarter as orders in Imaging systems, Patient care and Clinical Informatics were weak during the quarter.
The Consumer Lifestyle segment posted revenue growth of 10% to €1.0 billion ($2.5 billion) during the quarter. The segment report double-digit growth at Domestic Appliances, high single-digit growth at Personal Care and mid single-digit growth at Health & Wellness.
On a geographic basis, the segment reported strong double-digit growth from the emerging markets while the company witnessed mid single-digit growth in North America. Further, the company reported low single-digit growth in Western Europe and other mature markets.
During the fourth quarter, Phillips had transferred its Audio/Video Entertainment business to Funai Electric Co. for €150 million ($194 million). In addition, Funai will be paying a brand license fee associated with a licensing agreement for an initial period of five and half years, with an option to renew for another five years.
The deal related to the Audio, Multimedia and Accessories businesses is expected to close in the second half of 2013. However, the video business will be transferred in 2017, related to the existing intellectual property licensing arrangements.
During the reported quarter, the Lightningsegment reported sales decline of 1.9% year over year. Double-Digit growth at Lumileds and mid single-digit growth at Automotives was fully offset by declines in the other line business. LED sales grew 38% year over year and now represent 23% of the total lighting sales.
On a geographic basis, mature markets reported low year-over-year sales growth,which fully offset 2% growth in emerging markets.
Sales in the Innovation, Group & Services segment declined to 4.4% to €153 million ($159 million) from €160 million in the prior-year period.
Geographical Growth
On a geographical basis, comparable sales in the growth geographies increased 4% in the first quarter. Growth geographies represented 35% of total sales in 2012 versus 33% in 2011.
The company’s growth markets exclude the U.S, Canada, Western Europe, Australia, New Zealand, South Korea, and Japan.
The above mentioned geographies are classified as mature markets where revenues declined 1% year over year. The marginal decline in the mature markets was primarily attributable to weak sales in the Lightning and healthcare segment, which was partially offset by growth at Consumer Lifestyle.
Project Accelerate
Phillips introduced project Accelerate to improve its overall performance and reduce costs for the company. The project is expected to be operational till 2017. To date, Accelerate has generated cumulative savings of €145 million. In addition, Accelerate also helped reduced overhead cost generating a total of €549 million in overhead cost reduction, with an additional €78 million realized only in the first quarter of 2013.
In addition, Phillips was able to improve customer service by approximately 25% and about 85% of the senior employees have participated in change management programs in order to create a high-performance culture.
Cash and Balance Sheet
Cash flow from operating activities grew significantly to €1.2 billion ($1.5 billion) compared to €1.1 billion in the comparable prior-year quarter. The increase was attributable to higher net earnings and increase in provisions, which was partially offset by lower working capital.
Capital expenditures for the quarter were €310 ($402 million) versus €223 million in the year-ago period, due to higher investments in the Lighting and Consumer Lifestyle segments.
At the end of the first quarter, the company had a debt of €700 million ($908 million) compared to €713 million in the prior-year quarter. The decline in debt was attributable to a free cash inflow of €764 million, which was partially offset by treasury share transactions and cash outflow for discontinued operations.
VALUATION
Philips’ current trailing 12-month earnings multiple is 19.9X, compared to the 15.8X average for the peer group and 16.5X for the S&P 500. Over the last five years, PHG’s shares have traded in a range of 3.2X to 209.8X trailing 12-month earnings.
On a forward P/E basis, the stock is trading at a 4.2% premium to the peer group average. Though the stock is yet to reach pre-recession price levels, it did well in 2010, plummeted in 2011 and again gained back fairly in 2012. Now, the stock is again back on the recovery path as can be observed in the chart below. Growth prospects appear bright with the rising Zacks Consensus Estimate.However we maintain our Neutral recommendation on the stockas we expect the company to perform in line with the broader market. Our target price is $30.00 or 16.9x 2013 EPS, which is well within the historical range.
Key Indicators
Earnings Surprise and Estimate Revision History
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DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of PHG. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1020companies covered: Outperform- 14.8%, Neutral- 78.8%, Underperform – 5.6%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.
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