There are many routes to earnings growth. With GE HealthCare Technologies (GEHC -0.63%), it comes down to a combination of mid-single-digit percentage revenue growth and margin expansion. Over the medium term, management expects adjusted earnings before interest and taxation (EBIT) margin to move to "high teens to 20%", from 15.6% in 2022. A 300 to 500 basis points (bps) growth in operating margin is a compelling case, and there's reason to feel confident that the company can reach its aims.

The difference that profit margin expansion makes

To illustrate the significance of the targets, let's consider the improvement in EBIT implied by a combination of 5% revenue growth and hitting a 20% EBIT margin over the next five years. These figures imply a 64% increase in EBIT, so if GE HealthCare merely continues to trade at the same price-to-EBIT multiple it carries now, that implies a 64% return over the five-year period or a return of  about 10% per annum.

At the JPMorgan Healthcare conference in January, management laid out three components that will aid its margin expansion plans:

  • "Strategic pricing," including improving its value proposition through the use of precision medicine and other initiatives;
  • "Volume/mix," including a larger share of revenue from new product introductions (which tend to carry higher margins), higher software sales, and services;
  • "Productivity" actions include product platforming (developing a family of products based on a common platform) and simplifying its processes.

A cynic would argue that these pillars of margin expansion look beautiful on paper, but will be harder to achieve in practice. However, there's reason to believe that GE HealthCare Technologies can achieve all of them. 

How GE HealthCare Technologies can improve its margins

GE HealthCare was spun off from its parent in January, and some expect that it will be able to accelerate many of the plans described above now that it's operating as a stand-alone company with its own management in full control of its capital allocation priorities. Indeed, the company has already made an acquisition in the artificial intelligence (AI) field in order to add AI-enabled image guidance to its portfolio of ultrasound devices. That was in addition to the announcement in January of its agreement to buy computed tomography (CT) company Imactis.

Meanwhile, as the only medical technology company to offer imaging equipment and imaging agents, GE HealthCare is ideally positioned to grow in the emerging field of precision healthcare. Its imaging equipment is used in conjunction with its pharmaceutical diagnostic markers to diagnose patients, but they can also be used to precisely target drug delivery. 

As for new product introductions, 35% of equipment orders in 2021 came from new products that were introduced that year, and the company released 40 new products in 2022. 

What happened in 2022

The company's growth opportunity is clear, but it's easy to forget its potential to grow its margins by gaining back the ground it lost in 2022. One indication of this comes from its investor day presentation in 2022, when management forecast that what was then still the GE Healthcare segment would generate $3.1 billion to $3.3 billion in profit in 2022. In reality, that figure came in significantly lower at $2.7 billion. 

A number of things went wrong for the business:

  • The war in Ukraine lowered sales volumes. Ukraine and Russia typically account for 2% of its sales.
  • The lingering impact of COVID-19 constrained the company's ability to obtain key components and delayed equipment installations. 
  • Ongoing raw material and logistics cost inflation negatively impacted margins.

An example of just how severe these impacts were comes from the first quarter, when healthcare revenue rose by just 2%. However, GE CFO Carolina Dybeck Happe said that, absent the constraints discussed above, "we estimate that the revenue growth would have been about 7 to 8 points higher or year-over-year growth of approximately 9%."

Ultimately, GE HealthCare's stand-alone adjusted EBIT margin was just 14.5% in 2022, but as price increases flowed through 2022 and the supply chain issues eased, stand-alone EBIT margin improved to 16.1% in the fourth quarter of 2022. Moreover, management forecasts an improvement to 15% to 15.5% in 2023.

GE HealthCare's margin growth potential

The underlying improvement in its business and its potential to recover from a challenging 2022 speak to the opportunities for the company to significantly ramp up its margins and profitability in the coming years. As such, the earnings growth opportunity is real, and the stock remains attractive for investors.