GE Healthcare (GEHC 0.34%) had an excellent start to life as a stand-alone company in 2023, and the trend has continued in 2024 with a 15% gain already this year.
While it's easy to think of this recent spinoff from General Electric as a mature healthcare business, there is actually an investment case to be made for the company based on its growth opportunities. And it's those opportunities that are leading the stock to outperform.
Here's why GE Healthcare is an attractive stock for investors now.
GE Healthcare's growth opportunity
GE Healthcare is set to grow both its margins and revenue while also picking up the pace of its research and development (R&D) spending. You can think of its growth opportunity in three interconnected buckets:
- Margin expansion as a consequence of separating from its parent company, General Electric, and acting as a stand-alone operation.
- Successful new product introductions (NPI) resulting from previous and ongoing R&D.
- Opening up new market opportunities through investment and mergers and acquisitions (M&A) activities.
GE Healthcare's margins
Before getting into the details, it's worth pausing to reflect on the company's profit margin in 2023 because it's notably better than the headline numbers suggest. As you can see below, on an adjusted earnings before interest and taxation (EBIT) margin basis, it doesn't look all that impressive. After all, its margin declined in 2023, and the low end of the 2024 EBIT margin guidance only gets it back to 2022 margins.
However, CFO James Saccaro noted on the earnings call that "we incurred approximately $200 million of recurring stand-alone costs that impact our segment EBIT margin rates." He's referring to costs associated with the spinoff from GE. Adjusting for these costs by assuming they were in place in 2022 implies that margins grew by 14.5% in 2022 to 15.1% in 2023 and are set to increase again in 2024.
|
GE Healthcare |
2022 |
2023 |
2024 Estimated |
|---|---|---|---|
|
Adjusted EBIT margin |
15.6% |
15.1% |
15.6% to 15.9% |
|
Stand-alone adjusted EBIT margin |
14.5% |
15.1% |
15.6% to 15.9% |
Data source: GE Healthcare presentations.
Some of the reasons behind the underlying margin expansion come from initiatives taken as a stand-alone company. For example, the company delivered 3% growth from raising prices in 2023 and expects to deliver a further 1% to 2% as it starts realizing the full value of its portfolio of products.
Moreover, management claimed its productivity actions, such as product platforming (basing a collection of products on architecture or parts in common) were helping margins. Saccaro believes that "given our progress across the organization, we have solid visibility to deliver on our high teens to 20% adjusted EBIT margin target over the medium term."
New product introductions and new markets
These margin-expansion targets are impressive. After all, increasing the adjusted EBIT margin from 15.1% to 20% over five years implies a 32% increase in adjusted EBIT. However, if it's accompanied by 5% annual revenue growth, that growth increases to 69%. If you consider the stock is fairly valued right now, then the increase in earnings will result in a double-digit annual return for investors, provided the valuation stays constant.
After a year of 8% organic growth (boosted by supply chain improvements and the pricing actions referred to earlier), management expects 4% organic growth in 2024. It's a growth rate supported by ongoing new product introductions as a consequence of R&D investments as a share of revenue. However, as you can see below, the increased R&D isn't accompanied by margin expansion.
GEHC R&D to Revenue (TTM) data by YCharts.
GE Healthcare released 40 new products in 2023; its vitality index (the share of revenue from NPI) stood at 26% in 2023. Not only do NPIs drive revenue growth, but they also tend to come with larger margins.
Finally, the company is only in the early innings of realizing the potential of both imaging products and radiopharmaceutical products (diagnostic and therapeutic). The combination of the two is called theranostics. Combining imaging-equipment, diagnostics and therapeutics means drugs can be precisely delivered to their targets, such as cancerous cells, producing better patient outcomes.
Image source: Getty Images.
CEO Peter Arduini estimates the theranostics market "is approximately $9 billion and is expected to grow to $40 billion by 2032," and GE Healthcare is ideally placed in the market with its combination of imaging equipment and oncology, neurology, and cardiology diagnostic agents.
A stock to buy
Trading on 21 times forward earnings, GE Healthcare looks pretty well valued now. Still, if you are looking for a long-term play on the exciting growth market of theranostics, then the stock will suit you. In addition, its combination of revenue and margin growth means it's likely to be a solid performer for many years to come on this valuation.
