Philips Looks Better Without Lights

At its capital market day last week,

This supports our view of sustainable high growth and value creation. With strong intangible assets and increasing switching costs as the foundations of Philips’ healthtech moat, returns on invested capital are on the rise and substantially outweigh the company’s cost of capital.

We expect 400 basis points of revenue growth and 50 basis points of improvement in adjusted EBITA margin annually over our five-year forecast period, owing to the company’s strong market positions, increased focus after spinning off low-growth lighting assets, innovation, and cost optimization. We believe the market underestimates narrow-moat Philips’ value-creation opportunity.

New product launches scheduled for 2018 focus on increasing efficiency, data collection and sharing, and reducing harmful radiation doses for patients and doctors. These combined with a string of product announcements in the first nine months of 2017 will refresh close to 60% of Philips’ diagnosis and treatment product portfolio. We are pleased with the output of Philips’ annual research and development spending of EUR 1.7 billion (8.2% of sales), as the company’s broad improved product offering and strong distribution channel are gaining importance in a world where big buyers increasingly partner with large providers of medical equipment and services.

We foresee Philips’ recurring revenue as a percentage of sales increasing to 35% in 2021 from 28% at year-end 2016, owing to increasing maintenance support for medical devices, monthly fees from partnerships with hospitals, additional sales of software licenses (mainly in the connected care and health informatics division), and increasing use of consumables (mainly image therapy Volcano IVF products). Management revealed that the proportion of recurring revenue at the end of the third quarter was 30% of sales, a clear indication that Philips is on track to reach our target. With increasing recurring revenue and launches of competitive products in 2018, we expect market concerns about the sustainability of Philips’ success story to wane and the undervaluation versus our fair value estimate to fade.