This Foreign Company has Multiple Catalysts Higher

Royal Philips NV (NYSE: PHG) is a Belgium-based manufacturer in three segments: lighting, health care and consumer goods. The company manufactured its first light bulb more than a century ago and is the premier lighting supplier in Europe.

The health care segment accounts for 41% of sales but will expand once the company’s acquisition of medical imaging company Volcano is completed. Sales of consumer goods account for another 20% while revenue from lighting accounts for the remaining 39% of sales. Sales outside of Europe account for 75% of the total including 37% of total sales from high-growth developing nations and 30% from North America.

The company announced in September 2014 that it would split off the lighting business to focus on health care and consumer goods. Philips is also selling its consumer electronics division and combining the health care and consumer goods business. Shares jumped more than 6% on the announcement but have since come down on European economic weakness.

Some of the loss in ADR shares is a result of the depreciating euro against the U.S. dollar. The regional currency has dropped more than 12% over the last year on weak EU economic growth and a stronger dollar. Upcoming developments with Greek elections on January 25th and a meeting of the European Central Bank on the 22nd could mean more losses for the euro and uncertainty for the region. Investors need to be ready to ride out near-term volatility on factors that could ultimately prove to be big catalysts for growth.
 

Multiple Catalysts for Growth

Investors in Royal Philips can look to several areas for growth and return over the next couple of years. The spinoff of lighting into a separate business, probably completed late 2015, is the most obvious and will help management at both companies focus on different product lines. Shareholders of the lighting business should benefit from high cash flows with a dominant position in a mature industry. Shareholders in the health care and consumer business should benefit from strong growth and diversification.

More generally, Philips has several catalysts from a macroeconomic standpoint. Cheap oil will benefit the company in several ways. As a manufacturing company, production is energy intensive and will benefit from lower operating costs. The company will also benefit as lower energy prices lead to higher global GDP growth. It’s estimated that every $10 drop in oil prices increases global economic growth by half a percent. Stronger economic growth and lower energy prices means more spending by businesses and consumers, spending that could go to buying Philips’ products.

The currency weakness in the euro is a double-edged sword for dollar-denominated investors. A weaker euro means the company’s exports are less expensive when compared to other countries’ products which could increase sales. Earnings will also get a boost when sales made in other (strengthening) currencies are translated to euros.

The problem for dollar-denominated investors is that dividends are priced in euros before converting and being paid in dollars. Unless management increases the payout, a weakening euro means a lower dividend in dollars. I think the benefits from a weaker euro should offset a lot of the near-term pain and will prove a big benefit over the long-term.

The current dividend yield is an attractive 3.2% and the company has always offered a good cash return for investors. Philips repurchased EUR562 million in shares during fiscal 2013 and has increased the dividend by a compound rate of 4% over the last three years.

Valuation

Shares are trading for 0.96 times the last four quarters’ revenue, close to the 5-year average of 1.0 times sale but a big discount to the 4.1 multiple average given to competitors. A valuation discount is pretty common for diversified and conglomerate companies and the shares’ multiple may get a boost after the spinoff.

Sales will likely be flat this year but cost controls could drive better earnings and cash flow. I think the shares could be worth $35 leading up to the spinoff and provide for strong cash returns for years to come.

Upcoming elections in Greece on the 25th of January and a meeting by the ECB on the 22nd may mean more volatility for shares of European companies but I like the long-term outlook for Royal Philips. The company has several catalysts for upside including a spinoff that should offer support to investor sentiment through this year. The dividend could fluctuate on changes in the euro but the cash return is attractive and will increase when the euro eventually rebounds.