General Electric (GE 1.19%) has completed the first part of its breakup, and GE shareholders are now owners of GE HealthCare Technologies (GEHC 3.68%). But what should you make of the change, and are the shares worth selling, adding to, or initiating a new position in? Here's the lowdown.
Introducing GE HealthCare Technologies
In a nutshell, it's an imaging and ultrasound equipment company. It's an attractive market to be in, given that an aging population in the developed world needs more scans and diagnoses. Meanwhile, improving healthcare standards in the developing world is also a demand driver.
The company's full-year 2021 segment metrics are shown below. Patient care solutions include patient monitoring systems, anesthesia care, diagnostic cardiology, and maternal-infant care equipment. The high-margin pharmaceutical diagnostics business is exciting. GE HealthCare is the only imaging equipment provider to offer diagnostics (injectable agents and radioactive tracers) that improve scans and procedures.
| GE HealthCare 2021 |
Imaging |
Ultrasound |
Patient Care Solutions |
Pharmaceutical Diagnostics |
|---|---|---|---|---|
|
Revenue |
$9.4 billion |
$3.2 billion |
$2.9 billion |
$2 billion |
|
Segment EBIT margin |
13.0% |
27.9% |
12.2% |
34.3% |
|
EBIT |
$1.2 billion |
$0.9 billion |
$0.4 billion |
$0.7 billion |
|
Industry CAGR |
4%-6% |
4%-7% |
3%-6% |
4%-5% |
Data source: GE HealthCare Technologies presentations. EBIT is earnings before interest and taxation. CAGR is the compound annual growth rate.
Defining GE as an imaging company leads to comparisons with the West's other two major imaging players, namely Siemens Healthineers (SMMNY +0.05%) and Philips (PHG 2.48%).
A margin expansion opportunity in imaging
Before getting into the valuation details, it's worth noting that there's a surprising difference in profitability between the three companies' profit margins. For example, Philips had a 12.4% profit margin in its diagnostics and treatment business, compared to Siemens Healthineers' imaging segment's EBIT margin of around 21% for 2021 and 2022.
Combining GE HealthCare imaging and ultrasound into one gives an EBIT margin of 16.8% -- notably lower than that of its arch-rival Siemens Healthineers. At the GE HealthCare investor day in December, management said the company had a pathway to high-teens margins in imaging over the medium term, compared to the 13% you can see above. Siemens Healthineers' imaging margin is a target to aim for.
GE HealthCare valuation
It's common to look at relative valuations and absolute valuations. Unfortunately, this is easier said than done for this spin-off. For example, Philips also has significant businesses in personal health and "connected care" (analytics and care support). Meanwhile, Siemens Healthineers' combined profit from diagnostic, cancer therapies (Varian), and advanced therapies came to 1.58 billion euros in 2021, compared to 2.25 billion euros from imaging.
Nevertheless, taking Siemens Healthineers as a rough proxy, using its enterprise value (or EV, meaning its market cap plus net debt) to EBIT multiple of 18.9 and applying that to GE HealthCare management's estimate of $2.6 billion in EBIT for 2022 gives an estimated EV of $49 billion.
Data by YCharts
Calculating GE HealthCare's market cap from an EV of $49 billion is also complicated. The company has net debt of $8.5 billion, but it also has net pension benefit obligations of $5.2 billion. Conservatively, including the latter in net debt and stripping the combined figure of $13.7 billion out leads to a market cap of $35 billion -- some 33% above the market cap of $26.4 billion at the time of this writing.
Absolute value too
The stock also looks like a good value in terms of absolute valuation. For example, management estimates the company will generate $2.1 billion to $2.3 billion in free cash flow in 2022. Taking the low point of guidance ($2.1 billion) and applying a 20 times FCF multiple (reasonable for a mature blue-chip company) leads to a market cap of $44 billion, a whopping 66% premium to the current market cap.
Moreover, FCF generation amounts to around $9.3 billion over the last four years, a figure equivalent to 35.5% of the current cap.
|
GE HealthCare Free Cash Flow |
2019 |
2020 |
2021 |
2022Est |
|---|---|---|---|---|
|
Free Cash Flow |
$1.9 billion |
$2.5 billion |
$2.8 billion |
$2.1 billion |
Data source: GE HealthCare presentations.
Furthermore, FCF in generation in 2022 (and likely in 2023 as well) will arguably be artificially low due to the unprecedented supply chain issues (adding to costs, and impairing the company's ability to deliver products). Management started the year expecting EBIT of $3.1 billion to $3.3 billion and FCF of more than $2.7 billion, only to lower guidance to $2.6 billion and $2.1 billion to $2.3 billion respectively as supply chain issues persisted.
Still, with these issues hopefully starting to ease in the back half of 2023, GE HealthCare has an opportunity to expand margins and FCF generation. Meanwhile, organic orders growth of 4% compared to the third quarter of 2022 is in line with management's expectation of mid-single-digit revenue growth.
A stock to buy now
With management recently affirming organic revenue growth of 5% to 7% for 2023 alongside margin expansion and 85% FCF conversion and trading at attractive relative and absolute valuations, the stock looks like an excellent value.
Throw in the potential for medium-term margin expansion in imaging, backed by growth in high-margin pharmaceutical diagnostics, and GE HealthCare is an excellent stock to buy for 2023.
