In this post, I want to do a rough valuation of Koninklijke Philips (the ADR ticker is PHG). Philips provides healthcare imaging solutions, medical records solutions, respirators and other medical devices, as well as personal care devices such as electric toothbrushes and shavers. The company’s stock price hit a high around $61 in April 2021, and then proceeded to slide down ever since to the current price of around $18. It seems that a reason for this decline is due to a recall of respirators. I usually like to buy out of favor stocks due to some scandal or other temporary ailment, so PHG seemed right up my alley.
I recently read Bruce Greenwald’s Valuation book, and have been applying his different valuation approaches to the companies I am interested in. Here I will do a simplified “earnings power” valuation from the book. The first step is to figure out a reasonable revenue estimate going forward. In 2021, PHG did $19.5B in revenue, which is quite a bit down from the 2020 print of $23.8B. Looking at the past several years of revenue, Philips has not grown much, so a reasonable revenue estimate I’m using is $22B a year.
Next is operating margins. Over the past 10 years, Philips has had operating margins as low as 2.3% and as high as 9.5%. Usually margins are around 8% but there are a few bad years. For this analysis I’ll use 7% as a steady state operating margin. This produces $1,540M in operating earnings based on my $22B revenue figure.
Greenwald’s earnings power valuation uses an after tax earnings. Philips typically pays an effective tax rate of around 30%. This tax rate applied to the $1,540M in operating earnings produces an after tax earnings of $1,080M.
The next step is to capitalize the after tax earnings with a reasonable cost of capital to arrive at the estimated enterprise value. Looking at PHGs bond yields shows an average interest rate of around 6%. Another data point I use is to look at historical P/E ratios. Here, some of the average annual P/E ratios are very high, mainly due to low earnings that year and I guess the stock price did not decline much. Even with removing these outliers, the historical P/E has varied between 17 and 35, with an average around 20. Since the 6% cost of debt is higher than the historical earnings yield, I’ll stick with the more conservative rate of 6% (even though I feel like this value seems low).
By dividing the cost of capital by the post-tax earnings, we get the enterprise value of the company. Capitalizing the $1,080M in earnings by 6% produces an enterprise value of $18B. PHGs current enterprise value is $23B…so clearly the stock is still overpriced. Unfortunately, even though Philips has had a large drawdown, I am not seeing any margin of safety based on reasonable assumptions on what the business can produce. Therefore, Philips is a pass, but at least it provided a good valuation exercise.