Koninklijke Philips NV ($AMS:PHIA | NL0000009538) is a health technology company, but probably more known for it’s past history in consumer electronics. It is number 21 in the Noble 30 Index when measured by their dividend growth track record. Today I will share with you my quick analysis about Philips stock and asses whether I find it interesting to consider at the current share price.

Background

Philips is a company with its roots in the south of the Netherlands (Eindhoven). It was founded in 1891 by Gerard Philips and his father Frederik. They launched their business with their first products being light bulbs and other electro related products.

It was not an easy time though, because Philips almost ceased to exist after 5 years. The company was simply not selling enough, but luckily Gerard also had a younger brother Anton. It has been widely recognized that Anton and his ideas really brought the company to life with it’s rapid expansion as a company. He was also the successor of his older brother Gerard as CEO of the company.

This is how the story of Philips began and it’s simply a history book on its own to reflect on Philips as a company. What stands out though is its continuous reinvention through innovation and not being afraid to leave the past behind.

This is evidenced by the fact that it is currently listed as a Health Care company on the Amsterdam stock exchange (AEX). However, I’m pretty sure that most of our friends and families will still think about Philips as a Television and Light Bulb manufacturer.

It can’t be further from the truth though, because in the last 15 years alone Philips spun-off 2 large divisions which are rather big companies on their own now:

• 2006: NXP semiconductors – now 44 Bln market cap
• 2016: Philips Lightning (name changed into Signify) – now 4.4 Bln market cap

In 2012 Philips also sold it’s rights to produce and sell Philips branded televisions to TVP Technology. This is the reason why you still see TV’s being sold in your local electronics shops, although they are not manufactured and sold anymore by Philips itself.

Actually, it is probably good to know as an investor that Philips earns quite a substantial amount of money from it’s intellectual property and brands via licensing deals.

Fast forward to today: Philips is almost a pure healthcare technology player. In January 2020 they also announced to sell it’s domestic appliances businesses which produce for instance coffee machines, tooth-brushes and vacuum cleaners. There’s really not much left anymore from the old and original Philips once this sale is completed.

Having said that, let’s share some details about its strategy and how it’s making money today.

Philips mission today is the following:

We strive to make the world healthier and more sustainable through innovation

Philips Strategy (2020)

This has translated into a setup with 3 main business units:

• Diagnosis & Treatment: which unites the businesses related to the promise of precision diagnosis and disease pathway selection, and the businesses related to image-guided, minimally invasive treatments.
• Connected Care: which focuses on patient care solutions, advanced analytics and patient and workflow optimization inside and outside the hospital, and aims to unlock synergies from integrating and optimizing patient care pathways, and leveraging provider-payer-patient business models
• Personal Health: which focuses on healthy living and preventative care. 
  
  Source: press release 10 January 2019

It’s a nice distribution of the divisions, because they all make up about a third of their sales.

What I find interesting is that they earn 65% of all their revenues from being a leader in the specific market (meaning 1st or 2nd position by market share). They also generated around 53% of revenues from new products and solutions introduced in just the last three years.

This tells me that from this point of view Philips today is pretty much similar to 3M. Because 3M is a company widely praised for it’s innovation excellence.

I find this story even more remarkable, because Philips stock was really struggling about 15 years ago. It actually nearly went bankrupt due to strong competition from low-cost producers in Asia which just undermined Philip’s leadership.

If you’re interested to learn more about that story and it’s turnaround, then I would definitely recommend watching the below documentary 👇

Having said that, there’s much to like about the new Philips and I think that they found their mojo back. Shareholders also started to appreciate it, because the stock nearly doubled in the last 4,5 years.

As you can see, it was rather dead money in the preceding 20 years. During those times it was just trying to avoid a bankruptcy and transforming it’s whole business by spinning-off units, workforce redundancies and some targeted acquisitions.

And fresh from the press: Philips just announced to acquire BioTelemetry Inc. for 2.3 Bln Euro in an all-cash transaction. I can’t really judge yet about the value for money regarding this acquisition, but from a portfolio point of view it seems to be an excellent fit.

Having said that, Philips NV sounds to me like an interesting business again with some growth prospects. But is it also considered to be a good stock?

The question actually really is:

• would I like to consider it also in my dividend growth investment portfolio?
• Is the stock attractively priced today?

Let’s check it out!

Philips NV stock – Dividend Safety

Is Philips stock dividend safe? That’s the main question that I want to answer as a dividend growth investor. Let me therefore explore several determining factors first and then get back to you with my answer.

Philips Stock Profile

Philips Dividend history

An important factor for me is to look at the board of director’s credibility regarding past dividend payments. From that point of view the dividend history of Philips is a very interesting one.

From one side they have been able to maintain their dividend during one of their most difficult times in history (2008-2016). This just tells me that the board is really committed to their dividend.

From the other side you could argue that their dividend payments might have been foolish at times if you look at the payout ratios, because their earnings were far from stable over the last 30 years.

Having said that, Philips has not cut their dividend since 1993 after they reinstated it again. The last time they cut their dividend was in 1990 when they didn’t pay a dividend at all for about 3 years.

Having not cut their dividend for 27 years has earnt Philips a spot in the Noble 30 index. But as you can see, their dividend growth has hardly been beating inflation with an average of 1.96% between 2010 and 2019. The dividend growth was actually decent between 2000 and 2009 with a CAGR of 8.84%.

These growth numbers are not really something that excites me. To the contrary, it rather seems like a stock to avoid from that point of view!

Good news though, because last year they hiked their dividend with 6.25%

But what do you think, will a new decade bring new opportunities for proper dividend growth?

Earnings / Cash Flow

Let’s have a look at their Earnings and Cash flow numbers as well. Generally I prefer to see steadily growing numbers without too much volatility in the growth trend.

This may come as no surprise, but no, Philips is really not satisfying me here. Just look at the below graph. It looks ugly! Also have a look at the following calculation:

It just shows you that Philips total sum of dividends over the full decade where not covered by either Free Cash Flow or Earnings. This is not good!

However, let’s not be totally misguided by that, because as you can see, the dividend was nicely covered again in the last 4 years. This really aligns with their timing of the turn around by turning itself into a Health Tech company.

The board of directors also became a bit more bullish themselves, because they also started to repurchase their shares over the last two years.

The question therefore is: have they been using debt for this and do they have a healthy balance sheet?

Debt

So let’s have a look at their balance sheet then. Having too much debt and debtor obligations could put a growing dividend at risk as well. And I’m not sure yet on how much impact the last decade had on this.

Why the drop in 2017? Well, simple. They have used some of the proceeds from the sales of Philips Lightning to pay down debt. It didn’t last for long though, because in 2019 they have been leveraging up again with their most recent acquisitions and share buybacks 😉

All in all, I think that they have a rock solid balance sheet with a solid debt / equity of 61%.

I actually think that it’s a really a miracle that Philips was able to retain such a good balance sheet over the last decade with all the storms they were weathering. Using the proceeds from spin-offs to pay down debt has been a really good capital allocation decision.

This is the reason why they are now in a strong position to do very targeted acquisitions and grow their product portfolio.

The question remains though: do I find their dividend safe?

So let me answer that now: Yes, I do find their dividend safe.

The board of directors has shown to be very committed to their dividend and they are supported by a strong balance sheet. I also think that they have left their troubles behind them and earnings and cash flow are nicely covering the dividend again and growing.

I personally think that they are now at the beginning of a new s-curve. So let’s say that spring has started for Philips 🌞

Valuation

I’m not totally impressed with Philips, but as you noticed, I find their recent turn around quite promising. It might just be a good dividend growth stock for the upcoming decade.

But is now the time to buy Philips? Are they fairly valued or did we miss the boat already?

Let’s do two quick checks via the Dividend Discount Model (DDM) and a Discounted Cash Flow calculation before we draw some conclusions.

Dividend Discount Model – Philips Stock

We need 3 input parameters to calculate the fair value of Philips NV according to the Dividend Discount Model.

The first one is the annual dividend per share which is 0,85 Euro. That was a simple one.

The second one is typically much harder to get and that’s the Discount Rate or also called the Weighted Average Cost of Capital (WACC). We have luck here, because we can just use the number which Philips is using themselves already (slide 23): 7,5%.

The third one is a hard one. We have seen that they don’t have a strong track record in dividend growth over the last 10 years. So let’s just do some scenario analysis. I’m assuming 3 scenarios:

1. the average dividend growth rate from 2010 to 2019 – 1.96%
2. an average but still low growth rate of 4.5%
3. an average modest dividend growth rate of 6%

Plugging in the numbers gives me the following fair value numbers:

As you can see, the only time when the Fair Value of Philips is above the current stock price (meaning that Philips is undervalued) would be when we assume an annual compounded dividend growth rate of 6%.

I leave it up to you which scenario you chose, because a lot will be connected towards your own opinion about Philips NV growth prospects.

The dividend discount model is very simple and I’m personally more a fan of using a discounted cash flow model. Let’s see what a DCF calculation gives us.

Discounted Cash Flow

I like the discounted cash flow, because it is based on a company’s free cash flow and that’s a number which is the most hardest to manipulate by a board of directors.

The discounted cash flow allows you effectively to look at all incoming free cash flow in the upcoming years, but then discounted to the price of today.

Why do we discount it like that? Well, money is simply less worth in the future then it is today, because inflation and the cost of capital will make the same Euro less valuable in the future.

Having said that, I plugged in the numbers and I ended up with a Fair Value of 21,32 Euro.

Needless to say, but this number is way off from where the current share price trades.

Why is this? Well, the most sensitive numbers in this model are the starting Free Cash Flow (1300) and the Discount Rate (WACC).

I did some further browsing and I found that the board of directors is quite optimistic about their own growth forecasts up to 2025:

Let’s plug in their numbers as well and see what we get:

The above assumes a 15% Compounded Annual Growth Rate for their Free Cash Flow numbers to reach a FCF of 2 Billion Euro by 2025. This would not be unlikely if their sales growth is indeed 5% to 6% in the upcoming years if their profit margin indeed increases.

However, it does bring us much closer to the current share price. Actually, I also found another calculation in which they were using a 6.2% Discount Rate (WACC). Using that number will give us a fair value of 46,13 Euro which is much more in line with the current share price.

There are just two things wrong with that:

Firstly, 6.2% as a discount rate is historically extremely low and neither seems to price in the risk associated to a company like Philips. Secondly, 15% CAGR in Free Cash Flow is quite an opportunistic number. Luckily it is something that we can easily track over the upcoming quarters.

Having said that, using those numbers means that nothing may go wrong at all and the current interest environment should also stay until at least 2030.

I find this very unlikely and will therefore stick to my own fair value estimate of 21,32 Euro based on the Discounted Cash Flow calculation. Also this ensures that I’m using the same Discount Rate and FCF/Dividend growth rate in both calculations.

My overall Fair Value for Philips NV

I typically like to average out the two numbers from both the DDM and the DCF calculation and I will do this assuming scenario 3 from the DDM calculation (6% dividend growth). In this case the average of the two calculations gives me a fair value of:

38.99 Euro

Today the share price stands at 44,80 Euro. This means that I consider Philips NV stock currently 14,8% overvalued (18-December-2020).

Philips Stock – Final Thoughts and Considerations

I find Philips NV a very intriguing company. It’s not our father’s Philips anymore and it has almost become a pure Health Tech growth company. This is really a tremendous turnaround story and it slowly starts to reflect in the numbers.

Financially speaking they haven’t got a strong track record although they did manage to build a rock-solid balance sheet which gives them ample opportunities to acquire new companies.

Having said that, Philips NV might just be your next 5-bagger in the upcoming years or alternatively it might just stay a poor performing company as how it was over the last 10 years.

Therefore I find the investment case for Philips NV stock currently a full bet on the current board of directors.

I’m not sure whether I have my full confidence in them already. They surely have done a tremendous job in the turnaround and they do deserve the benefit of the doubt. Secondly they have also shown to be very committed to the dividend while maintaining a strong balance sheet.

It’s just that I need to learn more about them and I want to follow the company a bit closer over the upcoming months.

And this is what I’m exactly going to do. I will put it on my continuous watchlist and I will do another further thorough analysis once the price dips towards my fair value estimate.

I don’t expect that to happen soon, so I do have some time 😉

Disclosure: I don’t own Koninklijke Philips NV other than half a share from investing monthly in my Trading212 Noble 30 pie.

Quick Recap Philips Stock Analysis

Thanks for reading this far. Koninklijke Philips is definitely not an easy stock to analyse, but I hope that you found it insightful.

I’ve also tried to lay-out different scenario’s for you regarding their valuation so that you can chose the one that fits you best.

So tell me, what do you think? Would you like to own some Philips stock in your portfolio?

I’m eager to learn from you, so please leave your thoughts behind in the comment section below 🙏

PS: don’t forget that every comment = 1 Euro to Kiva.

Yours Truly

European Dividend Growth Investor