GE HealthCare Stock: Good Execution And Potential For A Re-Rating (NASDAQ:GEHC)

Investment Thesis

GE HealthCare Technologies Inc.’s (NASDAQ:GEHC) revenue growth is poised to benefit from healthy order bookings and backlog levels along with easing supply chain challenges which should improve backlog-to-sales conversion in the near term. In addition, the company’s revenues should also benefit from volume growth fueled by good end-market demand and strong execution.

On the margin front, easing inflation coupled with price increases and volume leverage should help margin growth in the coming quarters. In the medium to long term, the margins should see gains from the company’s focus on optimizing the G&A spend by rationalizing its real estate footprint and simplifying IT services and systems across the businesses. Coming to valuation, the company is trading at a discount to its peers and, as the company continues its good execution, I believe its P/E multiple can see a re-rating. Given the company’s good growth prospects and the potential of P/E re-rating, I have a buy rating on the stock.

Revenue Analysis and Outlook

GE Healthcare has seen good growth in recent years benefiting from good end-market demand as well as price increases. The company recently reported better-than-expected top and bottom-line results for Q3 FY23. In the quarter, the company’s revenue of $4.822 billion increased 5.4% Y/Y and 5.6% Y/Y organically driven by price increases and volume growth in its Imaging, Pharmaceutical Diagnostics (PDx), and Patient Care Solutions (PCS) segments.

In the Imaging segment, the revenue grew 4.7% Y/Y on a reported basis and 5.3% Y/Y organically attributed to growth in Molecular Imaging and Computed Tomography (MI/CT) and Magnetic Resonance (MR) product lines driven by supply chain fulfillment improvements, price increases, and new product introductions. The PCS segment’s revenue increased 9% Y/Y and 8.8% Y/Y on an organic basis due to increased sales in Monitoring Solutions and Consumables and Services product lines. In the PDx segment, revenue increased 12.8% Y/Y and 12.5% Y/Y organically driven by growth in EMEA and the Rest of the World due to price increases and improved demand. On the other hand, the Ultrasound segment’s revenue declined 1% Y/Y and 1.1% Y/Y organically as a result of tough Y/Y comparisons.

Looking forward, the company’s revenue outlook remains solid. The company had a healthy book-to-bill ratio of 1.03x in Q3 and ended the quarter with a backlog of $18.4 bn, which is ~$1 bn higher than pre-COVID levels. This healthy order rate and backlog bodes well for future revenue growth. Further, with easing supply chain constraints, the rate of conversion of backlog to revenue should improve further helping near-term revenue growth.

Despite the tough macroeconomic environment, customer sentiment remains upbeat. The pent-up demand from patients waiting to get procedures which get delayed during COVID is pushing up capacity investments from healthcare providers. On its Q3 earnings call, management noted that in its recently conducted customer surveys, the company continued to hear positive commentary around capital spending by customers in the second half of this year. So, order rates and revenues should continue to see healthy growth rates in the coming quarters as well.

In addition to good end-market demand, the company is also benefiting from strong execution. Last quarter, there were a lot of concerns about the demand environment in China. In July, China’s National Health Commission announced a crackdown on physicians receiving kickbacks from medical device distributors which led to several hospital directors being investigated and detained. This resulted in hospitals delaying the placing of orders and some of the company’s peers reporting a decline in orders in China.

However, the company reported strong sales growth in China despite this headwind and management also noted that orders in China increased Y/Y indicating strong underlying execution and market share gains.

Overall, the company has good revenue growth prospects driven by a healthy order book, strong end-market demand, and excellent execution.

Margin Analysis and Outlook

In Q3 2023, the company’s adjusted EBIT margin improved 10 bps Y/Y to 15.4% driven by higher volumes, productivity improvements, price increases, and higher-margin new product introductions which more than offset the higher operating expenses due to planned investments in R&D and cost inflation. Moreover, the standalone adjusted EBIT margin on a like-by-like basis (includes standalone company costs that were not factored in the previous year), which I believe is a better metric for margins, increased 120 bps Y/Y versus the Company’s estimated Q3 FY22 standalone adjusted EBIT margin of 14.2%.

Segment Wise, the Imaging, and the PCS segments’ EBIT margin improved 150 bps Y/Y and 120 bps Y/Y, respectively. However, the Ultrasound and the PDx segment’s EBIT margin declined 360 bps Y/Y and 230 bps Y/Y, respectively due to raw material inflation and increased planned investments.

Looking forward, the company’s margins are expected to continue benefiting from pricing increases it has implemented to offset cost inflation seen over the last couple of years. The cost inflation is also easing which should help gross margins. In addition, the company should benefit from volume leverage as the sales outlook remains positive. The company is also working on real-estate footprint rationalization and simplifying IT services and systems across businesses to create efficiencies as it scales. This should also help reduce G&A spending and improve margins in the medium to long run.

Valuation and Conclusion

GEHC is currently trading at a 17.90x FY23 consensus EPS estimate of $3.81 and a 16.03x FY24 consensus EPS estimate of $4.26.The stock looks cheap given its double-digit EPS growth prospects.

The company’s valuation is also at a meaningful discount versus its peer industrial companies with exposure to the healthcare end-market.

Table: Relative Valuation of GEHC versus peers

Click to enlarge

Source: Consensus Estimates (Seeking Alpha)

I believe as the company continues to execute well, it can see a re-rating in its P/E multiples. The company’s good revenue growth and margin expansion prospects coupled with a potential of P/E re-rating make it a good buy.