GE HealthCare: Encouraging Long-Term Growth Prospects (NASDAQ:GEHC)

Investment Thesis

GE HealthCare Technologies, Inc. (NASDAQ:GEHC) has good growth prospects moving forward. The company’s revenue growth should benefit from a healthy backlog of $19 bn, good momentum in order growth as well as easing year-over-year comparisons in the second half of the current year. Moreover, while the company is facing a demand slowdown in China (due to a delay in the rollout of stimulus funding), demand in the U.S. and in the rest of the world (ex-China) is healthy and bodes well for the company’s sales growth moving ahead. Further, China’s sales should recover from this temporary headwind in the coming year as the stimulus funding gets disbursed and orders accelerate, supporting the company’s overall topline growth. Lastly, higher prices within AI-enabled new product innovations should also support sales growth.

On the margin front, the company should benefit from volume leverage, improving product mix from high-margin new product innovations, and cost savings and productivity initiatives. The company is also trading at a discount to its peers who have similar growth prospects, which along with consensus expectations of double-digit EPS growth should provide an opportunity for P/E multiple re-rating and a good upside to the stock. Hence, I continue to have a buy rating on the stock.

GEHC Revenue Analysis and Outlook

Over the last couple of years, the company’s sales benefited from good demand in the end market due to recovery in elective surgery after post-Covid reopening, price increases, consistent new product innovations, and supply chain improvements. However, as I mentioned in my previous article, since the beginning of the current year, the company’s revenue growth has been facing headwinds from year-over-year tough comparisons and lower demand in China due to delays in government stimulus (2024 Stimulus Program) funding.

In the second quarter of fiscal year 2024, these headwinds continued to pressure the top-line growth. The company’s sales were negatively impacted by tough year-over-year comps from the previous year’s quarter which benefited from good demand and an increase in order fulfillment due to easing supply chain constraints. In addition, tough Y/Y comps in China and a decline in demand due to customers delaying their orders as they wait for the rollout of new stimulus funding also negatively impacted the company’s sales growth. This was partially offset by good demand in the U.S. and the rest of the world (ex-China) and new product innovations. As a result, total company sales increased by 0.5% Y/Y to $4.83 billion. Excluding unfavorable FX impact, organic sales increased 1.3% Y/Y.

On a segment basis, the Imaging segment’s revenue decreased by 0.9% Y/Y basis and was flat organically due to lower demand in China and tough Y/Y comps. The Ultrasound segment’s revenue decreased by 1.9% Y/Y and 1% Y/Y organically due to lower sales volume in China as a result of the end market slowdown. The PCS segment’s revenue increased slightly by 0.3% Y/Y and 0.6% Y/Y organically as tough comps from the previous year’s quarter offset good demand in the U.S. and new product innovations. Lastly, the Pharmaceutical Diagnostics (PDX) segment’s revenue increased by 12.5% Y/Y and 13.7% Y/Y organically driven by price increases, new product introductions, and volume growth thanks to good demand in EMEA and USCAN regions.

Looking forward, I am optimistic about the company’s growth prospects.

Last quarter, the company had ~3% YoY order growth (ex-forex). The company’s book-to-bill improved sequentially to 1.06x in Q2 2024 from 1.03x in Q1 2024, while backlog improved $300 million sequentially to $19 billion. This improvement in orders, book-to-bill, and backlog bodes well for the company’s growth in the quarter.

Further, the company’s sales should also benefit from easing comparisons in the back half of this year. Last year, the company reported low double-digits and high single-digit growth in Q1 2023 and Q2 2023, respectively. However, this growth slowed to mid-single digits in the back half. So, in the 2H2024, the company’s sales should also benefit from a meaningfully easier Y/Y comparison.

Another interesting thing is the company’s business is showing good momentum ex-China. If we exclude, ~300 bps headwind from China, the company’s orders were up 6% Y/Y. Its sales growth excluding China was 3.7% Y/Y in 2Q24 versus +0.4% in 1Q24. In the US, growth was ~+5% Y/Y 2Q24 versus flat in the first quarter. So, the underlying momentum remains solid.

Now, the slowdown in demand trend in China is temporary. The stimulus funding there got delayed and many of the clients paused orders waiting for more clarity around the stimulus. As the stimulus fund starts getting disbursed, the company’s order rate in China should meaningfully improve in the back half of this year which bodes well for the revenue growth in 2025. The company has already reduced its revenue expectations for FY25 in response to the temporary headwinds in China. So, the downside is limited and as order rates accelerate in the back half, the investor sentiment should turn positive.

Longer term, the company continues to execute well in terms of product innovation and including AI applications in its products. The company continues to lead the industry in terms of FDA clearance of AI-enabled devices. These products are not only helping the company’s sales volume but also helping it charge higher pricing given the value-add they bring to customers. So, I expect pricing/mix to benefit the sales as well moving forward.

GEHC’s Margin Analysis and Outlook

In the second quarter of 2024, the company’s margins benefited from the cost-saving and productivity initiatives as well as price increases which helped offset volume deleverage from the decline in China’s sales. This resulted in a 50 bps Y/Y increase in Adjusted EBIT margin to 15.3%.

On a segment basis, the Imaging segment’s EBIT margin expanded 40 bps Y/Y due to productivity gains and price increases which helped more than offset volume deleverage from the decrease in China’s sales. The Ultrasound segment’s margin declined by 120 bps Y/Y due to inflationary costs and volume deleverage from the decline in China’s sales. The PCS segment’s margin declined 80 bps Y/Y due to the unfavorable product mix and inflationary costs, partially offset by productivity gains. Lastly, the PDx segment’s margin grew 450 bps Y/Y due to volume leverage, productivity gains, and price increases.

Looking forward, I am optimistic about the company’s margin outlook.

The company’s margins should benefit from operating leverage on the fixed costs as sales growth accelerates in the coming quarters. In addition, the company’s innovation and focus on increasing software/AI applications in its products should help improve the mix of higher-margin software-related sales which should also help margins in the long run.

Management is also doing a good job in terms of productivity improvements and implementing lean manufacturing which should also help margins. In addition, the company is exiting legacy Transition Service Agreements (TSAs) and consolidating vendors to save costs. Below are a couple of relevant excerpts from the last earnings call where management gave examples of some of the cost savings/productivity initiatives they are undertaking,

In Waukesha, my team focused on improving our responsiveness to customer demand as well as cost savings for the CT and PET/CT products that we manufacture there. We create a visual management tool called Heijunka board that shows plant capacity, system availability and customer orders. The new tool will help us level load production, optimize manufacturing flow and meet customer demand while shrinking the lead time on our critical Omni Legend PET/CT system by 31%, and reduce future costs to create these scanners.”

Peter Arduini – President & CEO, GE HealthCare

In our PDx segment, we hosted a Kaizen in our court facility in May, which led to over 1.5 million doses of annual capacity improvement and cycle time reduction. This is another great example of how lean enables us to increase our volume and expand margins. In IT, we’re focused on permanent cost optimization actions that are resulting in ongoing cost savings. For example, we have consolidated more than 40 vendors supporting our applications to 1 vendor as we signed a managed service agreement that has resulted in more than $40 million of annual Savings. As we exit TSAs, we’re developing solutions specific to GE HealthCare’s needs. For example, moving more to the cloud and reducing internal data centers as well as consolidating the number of devices we use. We expect this to drive an additional $20 million of savings in 2024.”

Jay Saccaro – VP & CFO, GE HealthCare

Overall, I expect volume leverage, improving mix, and cost savings to drive the company’s margins moving forward.

Valuation and Rating

GEHC stock is currently trading at 19.62x FY24 consensus EPS estimates of $4.25 and 17.62x FY25 consensus EPS estimates of $4.74. The company’s valuation is at a meaningful discount to its peers who are trading over 25x P/E despite similar growth prospects.

Peers	FY24 P/E	FY25 P/E	FY24 EPS growth	FY25 EPS growth
Danaher Corporation (DHR)	36.46x	31.83x	0.13%	14.56%
Thermo Fisher Scientific Inc. (TMO)	28.32x	25.56x	0.87%	10.82%
Mettler-Toledo International Inc. (MTD)	35.67x	32.46x	6.25%	9.90%
Boston Scientific Corporation (BSX)	30.94x	27.36x	17.47%	13.07%
GE HealthCare Technologies Inc. (GEHC)	19.62x	17.62x	8.22%	11.37%

Click to enlarge

GEHC Relative Valuation (Source: Seeking Alpha)

As the company continues to execute well and some of the China-related headwinds subside, the growth should improve meaningfully in the coming quarters. This acceleration can help in the upward re-rating of the company’s P/E multiple. This coupled with double-digit EPS growth over the next few years should result in a good upside. Hence, I continue to maintain my buy rating on the stock.

Risks

• There is still some uncertainty about the rollout of China’s 2024 stimulus program. If the funds do not start getting disbursed in the 2H24, customers could continue to delay their orders, implying the drag from lower China sales could continue to impact overall sales in the coming year as well.

• Any execution issues on the cost-saving and productivity initiatives could negatively impact margin performance.