Image source: General Electric.
When you think of an "industrial" company like General Electric (GE 6.49%), you probably picture huge machinery, and you're not wrong. From aircraft engines to locomotives, GE derives a substantial amount of its revenue from selling giant hunks of metal.
But GE Healthcare is a bit of an anomaly. It operates on a much smaller scale. And it may become the sleeper superstar of GE's portfolio.
Here are three key takeaways for investors from GE's presentation at the recent Bank of America Merrill Lynch Global Industrials & EU Autos Conference that should leave you salivating at the prospects of the very small in the land of the very large.
Takeaway No. 1: It's a profitable business to be in
You could be forgiven for overlooking GE Healthcare. The company's last annual report features lots of sexy photos of jet engines and wind turbines, but not much about healthcare. "This is a business probably most of you didn't know exists inside GE," said Andrew Obin, Merrill Lynch's U.S. multi-industrials analyst at the conference. "Yet ... it's quite valuable. It represents as much as 10% of GE's market cap, based on our estimates."
The numbers bear this out. The business represents $18 billion in annual revenue and yields $2.9 billion in operating profits. Excluding GE's capital businesses, healthcare contributes 16% of both revenues and profits for the company. It has a strong market position and is the clear market leader in diagnostic imaging, which includes MRI and CT scanners.
Still, revenue was down 4% and profits were down 5% year over year in 2015. Margins shrank by 40 basis points. Management blames this slip on uncertainty surrounding the Affordable Care Act in the U.S., coupled with volatility in emerging markets. Other companies in this space were similarly affected. The healthcare division of 3M (MMM 0.70%), for example, saw net sales slump 3% in 2015.
But moving forward, the company anticipates solid single-digit revenue growth and hopes for double-digit earnings growth by expanding margins, improving sourcing, and growing services revenue.
Takeaway No. 2: The market is large and growing
The global healthcare market is massive. "It's a $7 trillion market," said Kieran Murphy, the CEO of GE Healthcare's life-sciences division, who presented at the conference. "In some countries, it's a huge percentage of GDP. In the U.S., it's almost 20%."
More importantly, it's growing. Murphy highlighted the opportunities in emerging markets, where GE has a "big footprint." Traditionally "Western diseases" such as cancer and diabetes are popping up in China, where GE has 5,000 employees. The company's investments in mobile diagnostics (for example, portable ultrasound machines) have the potential to unlock developing markets in Africa, where it's difficult to get patients to hospitals.
Healthcare spending is not only an imperative for developing nations, though. A mere 1% increase in overall healthcare efficiency worldwide would save $63 billion in annual spending. This bodes well for companies such as GE and 3M that operate in this space.
Even a booming market, though, isn't much of a plus if you get left in the dust.
Takeaway No. 3: GE puts the "industry" in "pharmaceutical industry"
Murphy also spoke about the investments GE is making in the future of medicine, particularly in state-of-the-art treatments for disease. He sees lots of potential in biopharmaceuticals: drugs produced by living cells.
"Seven of the top 10 drugs on sale in the world today are biopharmaceuticals," Murphy said. "The trend for the growth of biopharmaceuticals is extremely strong" -- on the order of 10%-15% per year for the next decade, he asserted.
"And the good news for us is that they are extremely difficult to manufacture," he continued. "Eight [biopharmaceutical] drugs got approved by the FDA last year. We were designed into all of those."
GE plans to replicate this success with investments into the emerging field of cell therapy.
Another trend that Murphy identified was "precision medicine." Drug therapies targeted to individuals will need to be manufactured on a much smaller scale than today's mass-marketed pharmaceuticals. "The multibillion-dollar drugs we have today ... are made in 20,000-liter bioreactors," he said. "In the future, the precision drugs are going to be made in smaller facilities using disposable technologies ... "factories in plastic," effectively. Which means that you can produce in small batches at lower cost."
GE has been one of the first movers in creating these smaller facilities, including the new "KUBio" modular facilities that can be bolted together in eight days to create a factory for 50% of the capital cost that uses 80% less water and energy. No other company, even 3M, is competing in this space. "We're the only game in town," Murphy said. Better yet, each KUBio unit comes with a recurring revenue stream for the software used to run it.
The big takeaway
GE Healthcare may be flying under the radar, but there's clearly tremendous opportunity for the business, which means there's also tremendous opportunity for the company as a whole.
Not only would growing sales and profits, of course, boost the company's bottom line, but success in emerging markets also helps to establish GE's brand there.
"As GE tries to do business with emerging economies, particularly in Asia and the Middle East, the first question that any government wants to tackle is healthcare, and then energy," Murphy said. "It's absolutely fundamental to their needs. So it puts GE in a great position as we try to embark on huge infrastructure projects." He added that it gives GE "first-mover advantage" in these markets.And for markets large and small, GE's investments in biopharmaceuticals, cell therapy, and precision medicine have big potential to pay off.
This presentation, and its underlying data, strengthen the long-term thesis for investing in GE. While the next couple of years may be rocky as the company divests its capital portfolio and streamlines its operations, it's poised to deliver outstanding results thanks to its investments in the future.
