Philips is currently trading below the price during the Covid-19 crash.

It has been a challenging year for Philips, and currently, their stock is trading below the price it reached during the Covid-19 crash. The reason is that they needed to recall millions of Respironics and sleep apnea devices due to potential healthrisks related to the sound abatement foam component they used. This is hopefully a one-time event and could present a great buying opportunity. In this analysis, I will investigate whether Philips is worth buying.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

It was a copier of mine who asked if I could take a look at Philips. It wasn't a company that I had considered investigating myself, and it hasn't been on my watchlist. However, as I want to keep my copiers satisfied, and considering the recent price action, I found it intriguing to explore whether the company is a worthwhile investment. For full disclosure, I should mention that at the time of this writing, I do not own shares in Philips. If you want to buy shares or fractional shares in Philips, you can do so at eToro.

Koninklijke Philips (Royal Philips) is a Dutch multinational conglomerate corporation that was founded in Eindhoven in 1891. It is a company that I have known all my life, and if my memory serves me right, I had a Philips TV when I was a child. However, the Philips of today is very different from the Philips of a decade ago. Philips no longer makes TVs as they sold the license to Japanese Funai in North America and Chinese TP Vision in the rest of the world in 2012. Their highly successful Philips Hue and other lighting products are made by the company Signify, which was spun off fromPhilips in 2016. Finally, they sold their domestic appliances business (coffee machines, vacuum cleaners, etc.) to Hillhouse Capital in 2021. When you invest in Philips, you are investing in the following segments: Diagnostics & Treatment (diagnostic imaging, ultrasound, enterprise diagnostics informatics, and image-guided therapy), Connected Care (monitoring and analytics, sleep and respiratory care, therapeutic care, and connected care informatics and population health management), and Personal Health (oral healthcare, mother and childcare, and personal care). Of the three segments, diagnostics and treatment accounted for the largest share with 51% of the sales in 2022. Connected care represented 25% of the sales in 2022, while personal health accounted for 20% of the sales in the same year. Additionally, there was a small "other segment" that contributed 4% to the total sales in 2022. Despite Philips changing their operations, I would still argue that they have a strong brand moat, thanks to their highly renowned brand.

Their CEO is Roy Jacobs. He joined Philips in 2010 and held several management positions until he became the CEO in October 2022. He holds two master's degrees, one in Business Administration and one in Marketing. As a leader, he describes himself as a realist and believes that it is crucial to lead with realism. He is a strong advocate for knowing the desired destination and developing a clear plan to achieve it. This plan should be easily comprehensible and inspireconfidence in others. It is the reason why he wants to change how Phillips is operating. He wants Phillips to remove complexity and become much more focused on strategy and innovation. When asked about Phillips' current position and future goals, he stated, "We need to shift our resources from being spread too thin across a wide portfolio to a more focused approach on creating growth and value in our segments and markets." As a realist, he said that there is no magic bullet to reach the goal and that execution will be the key driver to achieve it. While it is impossible to judge Roy Jacobs after such a short time as CEO, I appreciate that he has a clear plan and takes responsibility for the future of Phillips.Nonetheless, the quality of management is currently unknown.

I believe that Philips has a strong brand moat but the management is relatively unknown. Now, let us investigate the numbers to determine if Philips meets our criteria for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.

The first and most important number we will investigate is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all the numbers being above 10% in each year. Looking at the numbers from Philips, they are very underwhelming. Philips has only had two years in the last decade where they managed to deliver a return on invested capital (ROIC) above 10%. It seemed like Phillips was back on track in 2021, but then came a horrible 2022 that was affected by the recall of their Respironics devices. Management believes that from 2025 and onwards, the return on invested capital (ROIC) will be in the mid- to high teens. Thus, they believe they will return to the 2021 figures.Nonetheless, I will need to see it to believe it.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. The numbers have been somewhat mixed over the years, but Phillips has managed to maintain relatively stable figures. It is promising to see that the headwinds in 2022 didn't affect the equity too much.

Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. The numbers are a big mix throughout the years, with 2021 being the best year when looking at levered free cash flow margin and free cash flow yield. It is not surprising that 2022 was a disastrous year due to the recall of their Respironics devices.

Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do so by dividing the total long-term debt by earnings.We cannot make the calculations for 2022 as Phillips had negative earnings. However, based on previous years, the calculations indicate that the debt-to-earnings ratio was 1,44 years in 2021, 3,91 years in 2020, and 3,23 years in 2019.Thus, while there have been years when debt exceeded three years of earnings, it is not cause for alarm.

Like with all other companies, there are some risks associated with investing in Philips. The first and most obvious risk is the recall of Respironics devices, which can have various impacts on Philips. The recall means that their restructuring, acquisition-related, and other charges came in at 350 million euros above their guidance. Furthermore, a recall like this can have catastrophic consequences for the brand. If their brand is damaged by the recall, it could weaken their competitive advantage and impact their future sales. Luckily, strong brands usually bounce back from events like these, as we have seen on numerous occasions before. Another risk is supply chain shortages. Philips has more than 5.000 suppliers, which has resulted in challenges for Philipsdue to the complexities of the global supply chain. In their 2020 fourth quarter earnings call, management mentioned that although the component supply chain is improving, the situation remains challenging. Management wants to reduce the number of suppliers but has mentioned that this will be a multiyear effort. Thus, the supply chain will continue to pose a risk for years to come. Macroeconomics. Management mentioned that in 2022, component and wage inflation affected the EBITDA margin by 3%. Furthermore, they stated that they anticipate a continued significant increase in wage and component inflation in 2023. Furthermore, management expects that uncertainties in the external economic environment will affect sales in their Personal Health segment. As a result, management has lowered their expectations to low single-digit growth.

There is also a lot of potential for Philips moving forward. They currently have a substantial backlog of orders. In the 2022 fourth quarter earnings call, management mentioned that their order book is significantly higher than it was in 2019 and 2020. They mentioned that, in absolute terms, the order book was 30% higher by the end of 2022 compared to 2020.The order book was lower by the end of 2022 compared to 2021, which was due to Phillips canceling orders. However, management believes it is a positive development as the cancelled orders were low-margin orders. This means that despite the decrease in the number of orders in 2022, they are expected to have higher profit margins. They expect to resume their growth. With their new business strategy, in which Phillips will be more focused on key markets, management expects that they will resume growth. Management mentioned that they will prioritize and drive growth across Image-Guided Therapy, Monitoring, Ultrasound, and Personal Health. These are businesses where they can accelerate growth and margins more quickly due to their strong leadership positions. It means that Phillips expects to see impacts next year, with the goal of reaching their full potential in 2025. This is why they have guided for a high return on invested capital (ROIC) in 2025.. Some macroeconomic factors could benefit Philips. Management has discussed the severe challenges that the hospital system is currently facing. They are facing higher costs due to inflation and staff shortages. It means that hospitals need to increase staff productivity and improve efficiency. To do so, they look at companies like Philips that have products that deliver a pathway to optimization, resulting in better staff productivity. Furthermore, management also mentioned that hospitals need to catch up with technology due to underinvestment during Covid. This could lead to a higher number of investments from hospitals moving forward.

All right, we have gone through the numbers, risks, and potential regarding Philips and now it is time for us to calculate a price. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. Remember that Phillips had negative earnings in 2022. I chose to use an EPS of 1,5 euros. The number is lower than that of 2021 but the highest since 2017. I chose an estimated future EPS growth rate of 5%, which is in line with their expectations. Estimated future PE is 10 (which is double the growth rate, as the historical PE for Philips has been higher)and we already have the minimum acceptable return rate of 15%. Doing the calculations, we arrive at the sticker price (also known as fair value or intrinsic value) of 6,04 euros. To ensure a margin of safety of 50%, we will divide it by 2. This means that we aim to purchase Philips at a price of 3 euros or lower, using the Margin of Safety price.

Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. Phillips had higher expenses than income in 2022, so it is not possible to calculate based on the 2022 numbers. However, the calculation based on 2021 looks like this: The Operating Cash Flow last year was 1.629. The capital expenditures were 763. I tried to look through their annual report to see how much of the capital expenditures were used formaintenance. I couldn't find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 534,1 in our further calculations. The tax provision was -103. We have 904,3outstanding shares. Hence, the calculation will be as follows: (1.629 - 534,1 - 103) / 904,3 x 10 = 10,97 euros in Ten Cap price.

The last calculation is the Payback Time. It is also described in "MY STRATEGY". Phillips had a negative free cash flow in 2022, so it is not possible to calculate it based on the 2022 numbers. However,the calculation based on the 2021 numbers is as follows: With Phillips' Free Cash Flow Per Share at 1,53 and a growth rate of 5%, if you want to recoup your purchase in 8 years, the Payback Time price is 12,24 euros.

I believe that Philips is an interesting company, as they have just restructured their business. I believe that Philips is an interesting company because they have recently restructured their business. And if management can execute their new strategy, they could achieve higher profitability than before. Nonetheless, the management is unknown, so only time will tell if they manage to do so. Philips is currently experiencing an event with the recall of their Respironics devices. What I mean by that is that it is a one-time event that will not happen again. While Philips expects to deliver all the modified Respironics devices soon, the process is not yet complete. They are defendants in several class-action lawsuits and have received a subpoena from the U.S. Department of Justice to provide information related to theevents leading to the recall. So far, we don't know what it will amount to, so it needs to be monitored. I must admit that I am also underwhelmed with the numbers Philips has delivered over the last 10 years. However, Philips is a new company since its restructuring and strategy, and it will be interesting to follow its progress to see if it can deliver improved results.Nevertheless, I do not intend to invest in Philips at the moment, as I believe there are far superior opportunities available.

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