$FPH resported their 1H results yesterday.

Their Highlights

• 12% increase in net profit after tax to $107.3 million, 22% increase in constant currency.
• 16% increase in operating revenue to $803.7 million, 16% increase in constant currency.
• 11% increase in Hospital operating revenue to $487.5 million, 11% increase in constant currency.
• 19% increase in constant currency for new applications consumables (products used in noninvasive ventilation, Optiflow nasal high flow and surgical applications) accounting for 70% of Hospital consumables revenue.
• 26% increase in Homecare operating revenue to $314.4 million, 25% increase in constant currency.
• 28% increase in constant currency for OSA masks and accessories revenue.
• Investment in R&D was 12% of revenue, or $96.9 million.
• 3% increase in interim dividend to 18.0 cps (H1 FY23: 17.5 cps).

My Analysis

The 16% growth in operating revenue (CC) is well above their long-term aspirational goal of 12% revenue growth p.a., and with the second half typically stronger for the larger hospitals segment due to buying patterns, they remain on track to achieve FY$1.7bn sales, per guidance.

Homecare grew pleasingly strongly with cc revenues up 25% over pcp (26% reported basis), within which there was particularly strong growth for OSA masks and accessories (+28% in CC). There has been positive feedback from new face masks and other new products.

In the Q&A there was the expected question on whether $FPH is seeeing any impact of GLP-1s in Homecare. The answer, a simple "no" and the explanation was because the OSA market is under-penetrated and $FPH have low market share.

In Hospital care, new products are growing strongly at 19% in cc, including the new air humidificaton products. Overall Hospital care growth of 11%. Expectations for 2H have been managed, due to the cycling of strong results in the PCP due to the China surge and RSV in the US, creating a challening baseline for the 2H pcp comparison.

On Gross Margin, there was progress of +65bps (+192bps cc) to 60.5% and CEO Lewis and CFO Joy both reiterated their confidence that %GM will progressively drive back to >65% over the next 3-4 years.

Opex growth at 16% was significantly higher than the 12% guidance given for the full year, which contributed to the NPAT advance of 12% behind revenue growth, albeit achieving 22% in cc.

$FPH are going through a process of significantly expanding their manufacturing facilities, having recently made a large Auckland land purchase, commissioned facilites in Mexico and working to bring a new facility online in China in the next 6 months. Guidance for FY capex was reduced from $450m to $350m, to reflect phasing of building.

Total debt of $243m, a change from $FPH historically holding no net debt, has been required as a result of the major expansion in manufacturing facilities to support the next phase of growth. However, at less than 1x forecast NPAT of $250-260m it remains conservative, refflected in the financing expense of $12m for the half.

My Key Takeways

Overall, strong revenue growth, the start of recovering %GM, offset somewhat by increasing Opex, adds up to a good result for FPH.

Forecast FY24 NPAT of NZ$255m on NZ$1,700m revenue, brings $FPH to a %NM of 15% - potentially the low point as margin recovery progresses from here.

On valuation, with a FY24 forward P/E of 54, $FPH is fully-valued on a fundamentals basis, and is trading slightly above its 5-year average p/e of 48-50. The strong revenue growth is parhaps shaking off some of the recent GLP-1-induced market funk, bringing the SP back to where it was earlier in the year post FY23 results, when the market had digested the weaker %NM position of the business.

The strong Homecare revenue growth result is another good read-across to $RMD.

I remain a long term holder of $FPH, albeit my holding of this stock is small in comparison to $RMD.

Disc: Held in RL but not on SM.

$FPH published their FY23 results today. While at the headline level, earnings have dropped off a cliff over the last 3 years, there is a lot needed to unpack the results, as follows. 

In 2020, in the global scramble by hospitals to source hiflow devices and, frankly, the entire $FPH hospital range, $FPH ramped up output to drive volume at the expense of margins.  FY21 and FY22 saw demand peak then fall, and margins and volumes got hit due to supply chain constraints. In 1H FY23, hospital volumes plunged, as pressure came out of global hospital systems in most regions, and these were able to run down inventories. FY23 was a game of two halves, with 1H cycling strong pandemic-impacted numbers, with H2 looking more like a return to BAU.

On homecare, the same competitor recall that helped $RMD, boosted demand for $FPH, offset by supply chain constraints and fewer clinic sleep clinics visits and diagnoses for OSA during the pandemic. Headwinds have now turned to tailwinds, and Phillips is yet to return to the market.

So, today, CEO Lewis Gradon focused his presentation on the H2 results, and CFO Lyndal York gave clear guidance on how gross margin (GM) and operating margin (OM) are expected to trend over the coming years, as $FPH refocus on profitability and return to their long term goals of 65% GM and 30% OM.

Because of this I have listed their highlights for both the full year and the half year.

Overview of key results for the second half of the 2023 financial year

• 14% growth in operating revenue to $890.5 million, 12% growth in constant currency.

• Net profit after tax of $154.4 million, a decline of 0.5% or 3% in constant currency.

• 9% growth in Hospital operating revenue to $584.8 million, 7% growth in constant currency.

• 13% constant currency revenue growth for new applications consumables; i.e. products used in noninvasive ventilation, Optiflow nasal high flow therapy and surgical applications, accounting for 72% of Hospital consumables revenue.

• 25% growth in Homecare operating revenue to $303.9 million, 22% growth in constant currency.

• 28% growth in OSA masks revenue, or 24% growth in constant currency.

Overview of key results for the 2023 financial year

• 34% decline in net profit after tax to $250.3 million, 39% decline in constant currency.

• 6% decline in operating revenue to $1.58 billion, 9% decline in constant currency.

• 15% decline in Hospital operating revenue to $1.02 billion, 18% decline in constant currency.

• 6% constant currency revenue decline for new applications consumables.

• 18% growth in Homecare operating revenue to $553.8 million, 13% growth in constant currency.

• Investment in R&D was 11% of revenue, or $174.3 million.

• 2% increase in final dividend to 23.0 cps (2022: 22.5 cps).

• 3% increase in total dividends for the financial year to 40.5 cps (2022: 39.5 cps).

My Key Takeaways

Strategically, Lewis was clear to point out that the pandemic has provided a catalyst for $FPH to scale up its manufacturing base (NZ and Mexico) and sales and marketing team, to support a much-expanded revenue base. Although capex will be high as they establish their second NZ campus, the margin head-room both in %GM and %OM, means that they should now be able to drive above pre-pandemic trend earnings growth, aided by a strong new product pipeline in both hospital and home.

I was somewhat surprised that freight costs were called out as a major contributor to lower margins. Having looked into this, while sea freight has come back to pre-pandemic levels, air freight rates are still elevated and, therefore, I assume a lot of $FPH’s products use this mode.

Given the SP run-up this year, the (superficial) optics of earnings decline and the high p/e multiple, the SP was in my opinion always going to fall today. And because of the turbulence of the last 3 years, it is possible that the analysts are going to have trouble modelling the path forward – so we might see a divergence of valuations, likely weighted to downside. (Personally, that's good new for me.)

Anticipating this risk, I halved my holding recently on the back of $RMD results (which is where I reallocated the capital). I will wait to see how the SP tracks over the coming days and, if the downgrades and traders drag it down, I’ll strongly consider renewing my allocation with fresh $, probably around $21.00 - $21.50, as an entry point (subject to updating my valuation), if Mr Market is so inclined to oblige me.

This is a quality company. I aim continue to hold for the long term, and will happily add at the right price. Taking a step back and looking at the last 3 years, I think management has done a fantastic job in responding to the demands placed on the busines by the pandemic and contributed to saving many lives. The trouble this has caused us analysts to build our forward models is surely a small price to pay!

Next update will be their investor day at the facilities in Mexico in September. I hope like last year this will be live streamed, as my holding doesn't quite justify making the trip.

Disc: Held RL (1.6%); not held on SM.

First up, big thanks to @BoredSaint and @Chagsy for your valuations and posts on $FPH, which prompted me to take a look at my own valuations. See @Chagsy’s post for the many good reasons to hold the stock. (As a side note, I’d just finished reading the Economist article you quoted over breakfast on Saturday, when I read your post!) 

Market mis-pricing

For such a consistently performing long-term growth stock, the market has had a lot of difficulty pricing $FPH during the pandemic and its aftermath. Just consider the broker reports.

In late 2019, Goldman Sachs had a 12m price target of A$17.30 (consensus at the time was just under A$17). 

Now, $FPH was a huge COVID beneficiary. With ventilators in short supply globally, the hi-flo masks were snapped up and clinical evidence was widely reported of the benefits from their use. This expanded the global fleet and hospital presence massively, and they benefit on an ongoing basis from all the consumables.

By early 2021, Goldman Sachs valuation was $38.80, ahead of a consensus view of over $35.00 and a SP peak of $34.27.

Once the global COVID peak passed, supply chain problems and inflation rose and the outlook for interest rates turned hawkish, the SP collapsed to $16.05.  This was driven by falling sales due to hospital destocking, high inventory and supply costs due to supply constraints, freight costs, component shortages etc. In addition, cash flow hit due to high tax payments (from the COVID super-profits), investment in new facilities including in Auckland and Mexico.

$FPH is widely considered to be able to sustain moderate growth over the long term. Their strategic framework assumes 12% real revenue growth in perpetuity, at a 65% gross margin and 30% net margin. With margins hit hard post-COVID, and sales in "decline", the market punished this growth stock, in my view over-reacting to the numbers immediately in front of it. In addition, as a growth stock the valuation got hit hard as interest rates rise, given that so much of the SP lies in long-dated cashflows. (If continuing free cash flow growth rate is high, then the valuation is super-sensitive to the WACC.) 

By September 2022, Goldman Sachs had progressively downgraded the SP target to $17.90, a 53% fall from their peak target 18 months earlier. (The pattern for the rest of the market was similar, albeit not as extreme as GS, which tends to be a FPH bull.)

I have been unable to get a hold of GS research note from November 2022. However, on the back of the Half Year results, the TP was raised back to $27.00. (Yes, I was suffering whiplash by this time.) The re-setting in SP expecations was no doubt due to the analysts call the bottom and realising that it was not that bad.

Where to from here

Last week, FPH provided a revenue update which was ahead of consensus of between $1550 and $1600m. Although no margin guidance was given, the outlook is assumed to be as given in November last year.

Following the announcement, there have been a series of upgrades. E.g., This morning UBS upped their price target by 10% to NZ$26.67 (which I make about A$24.80, i.e., about where the SP is.)

Healthcare stocks have generally started the year strong. In a year where there is still an outlook for a recession in many market globally, the healthcare sector will be a sought after destination for equity funds, and certaintly in favour while the market remains risk-off.

Looking at $FPH, specifically fundamentally, little has really changed. In a model I have of the business valuing it at $17.50 (at current interest rates) at the end of 2019, had COVID19 not happened, this would today be worth $24.00.

But some things have changed. COVID-19 significantly expanded their global reach and the base from which consumables sales and upgrade revenues will flow. The transient effects on sales, margins, cash flows etc. have played havoc with the financial accounts, as is reflected in both the share price and analysts’ gyrations.

In, addition, as @Chagsy points out, we have a generally sicker global population, with 'flus resurgent, and China's strong COVID demand a driver for the next several months.

While I considered selling on the recent SP stregnth, I am comfortable holding $FPH at $24-25/sh. (My valuation models says it could be worth anything between $19 and $28, depending on how long they can sustain the growth model: of 12% sales growth, 65%GM and 30%OM, which could be conservative.)

For those who are concerned about the fwd p/e of 60+, based on the current consensus, I note that the consensus is still showing forecast 2023 revenue of only $1525m, and an Operating Margin of 20%. While margins are indeed below their (FPH’s) current model of 30%, I am forecasting that they get back to 23% this year, 27% in FY24 and 30% by FY25. So, my forward p/e’s over 2023 to 2025 are: 57, 45, and 37. (Note: inflation is not a major issue for them as they have quite good pricing power in the hospital segment.)

From a traders’s perspective (not me!) it also looks like we are returning once more to an upgrade cycle. However, the result in May will determine just how strong this is.

For now: FPH is a HOLD for me, even though I recognise there could be some profit taking in the coming weeks, and should margins disappoint we'd see a sell-off after May results. However, management are historically conservative and if there was a profit problem, I'd have expected to see a more explicit indication of this in last week's release.

Disc: Held in RL. Not on SM.