When you start learning about finance, one of the first misconceptions you run into is that the market is perfectly efficient or very close to it. Legendary investors like Warren Buffett, Peter Lynch and countless others follow the school of value investing ideology, have proved that this idea is wrong. Over time frames, sometimes lasting years, the market can be inefficient, especially when it comes to individual securities. A good example of this can be seen by watching GE Healthcare Technologies (NASDAQ:GEHC), the health care business that was spun off from the industrial conglomerate General Electric (GE) earlier this year.
The last ITEM that I published about GE HealthCare Technologies stock came out in July of this year. It was one of the few companies I had rated as a ‘strong buy’. Such a designation reflects my belief that the stock should pass over the long term, significantly outperform the broader market. As I wrote earlier this year, my overall track record for ‘strong buy’ prospects is pretty solid. But not all of these shows turn out the way I would like. So far, GE HealthCare Technologies has badly underperformed the broader market since my last article was published. During that time period, the stock has fallen 16% at a time when the S&P 500 has risen 0.6%.
There is an important advantage
The recent weakness from a stock price perspective has not been driven by fundamentals, but instead by market sentiment. I say this because latest financial data provided by the management has been encouraging. This data covers the third quarter of fiscal year 2023. During that time, revenue for the company reached $4.82 billion. This is 5.4% over the $4.58 billion generated a year ago. The biggest improvement, from a year-over-year growth perspective, has been from the company’s PDx segment. This is the part of the business that focuses on the pharmaceutical diagnostics space. This unit operates primarily as a supplier of diagnostic agents to the global radiology and nuclear medicine space. These agents are complementary to the firm’s equipment in other segments, so it stands to reason that the more those segments grow, the more this particular segment will grow over the long term. During the quarter, revenue for this unit was $589 million. That’s 12.8% over the $522 million generated at the same time last year. Management attributed this to higher prices and higher demand for certain regions such as EMEA (Europe, Middle East and Africa) and the rest of the world areas where it operates.
The company also experienced growth in other countries. PCS, or Patient Care Solutions, experienced sales growth of 9%, with revenue rising from $701 million to $764 million. This is the part of the enterprise that provides customers with medical devices, consumables, services and digital solutions, all of which are centered around larger organizations and teams. This increase in sales is attributed to growth in several product lines such as Monitoring Solutions, Consumables and various related services. Management chalked the increase up to strong demand improvements in supply chain fulfillment and higher prices.
And finally, the Imaging segment, which is responsible for various scanning equipment and related technologies such as those involving CT scans, MRIs, X-rays and more. Revenue under this unit managed to grow 4.7% from $2.52 billion to $2.64 billion thanks to growth and demand for molecular imaging and computed tomography and magnetic resonance equipment, as well as supply chain fulfillment improvements, higher prices for products that the company sold, and the introduction of new products. In fact, the only weakness for the quarter came from the Ultrasound segment, which saw revenue decline 1% from $823 million to $815 million. That decline, management said, came from the easing of supply chain restrictions last year that temporarily boosted revenue then.
The increase in revenue for the company, unfortunately, did not result in higher profits. Net income actually managed to fall from $487 million to $375 million. While the company suffered from higher interest expenses and a fairly significant increase in research and development costs, profits would still have been higher year-over-year had it not been for the nearly doubling of income tax expense. from $129 million to $250 million. Other profitability metrics, fortunately, came in much stronger. Operating cash flow increased from $622 million to $650 million. But if we adjust for changes in working capital, we get a fairly substantial increase from $415 million to $714 million. And finally, EBITDA increased from $316 million to $897 million. As the chart above illustrates, financial performance for the first nine months of 2023 compared to the same time last year was largely similar to the third quarter of this year compared to the same quarter last year. However, cash flow figures in some respects were weaker this year than last year.
For this year as a whole, management expects organic revenue to be between 6% and 8% higher than last year. Management also raised earnings guidance, with earnings now expected to be between $3.75 and $3.85 per share. That’s $0.05 per share higher than previously expected at the low end of the scale. This should translate into net earnings of about $1.74 billion. Based on my estimates, adjusted operating cash flow should be around $2.48 billion, while EBITDA should come in somewhere around $3.62 billion. Assuming these estimates are correct, the company should be valued as shown in the chart above. As you can see, the stock is slightly more expensive compared to last year on a price-to-earnings basis. But when it comes to the other two profitability metrics, it should be a little cheaper.
|Price / Earnings
|Price / Operating Cash Flow
|EV / EBITDA
|GE Healthcare Technologies
|Thermo Fischer Scientific (TMO)
|Agilent Technologies (or)
|Mettler-Toledo International (MTD)
|Siemens Healthineers AG (OTCPK: SMMNY)
As part of my analysis, I then created the table above. In it, you can see how GE HealthCare Technologies fares against five similar firms. To save you some time, I ran the numbers myself and concluded that, regardless of the valuation metric we use, GE HealthCare Technologies is the cheapest of the bunch. To see what kind of positive potential the firm could offer, I then created the chart below. In it, you can see how much upside the stock would have at each of the valuation approaches if the stock were trading at the same multiple as the next cheapest player in the space. In addition, I also estimated the multiples of the five companies I compared it to and calculated what kind of upside shares would experience in that scenario. Even in the worst case, we’d be looking at a 52% increase. And then the best case, the upside would be 102.5%. So you can see why I’m as bullish about business as I currently am.
Based on all the data provided, I have to say that I am extremely optimistic about the future of GE HealthCare Technologies. While it’s true that some of the cash flow numbers may look better than they currently do this year, the stock looks attractively priced, both on an absolute basis and relative to peers. Revenues continue to grow and management even raised earnings guidance at the midpoint. In the absence of anything significant changing about the business, I’d say there’s likely to be further improvement here. And because of this, I have decided to keep the company rated a ‘strong buy’ for now.
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. stock exchange. Please be aware of the risks associated with these stocks.