Siemens Healthineers: Softer Orders A Risk, But The Story Remains Sound (OTCMKTS:SMMNY)

Despite worries about hospital budgets, healthcare capex has held up pretty well over the last 18 months, and Siemens Healthineers (OTCPK:SMMNY) (SHLG.DE) has leveraged innovative new products into that healthy market to continue generating more than respectable revenue growth, albeit with some unexpected margin challenges along the way.

Siemens Healthineers shares are up about 10% since my last update, modestly outperforming the broader medical device space and GE HealthCare (GEHC); while Philips (PHG) has done even better, I’d argue the special circumstances there are relevant, and if you look out over a longer time frame, Siemens Healthineers has handily outperformed its Dutch rival.

I’m still generally bullish on the shares. I like the innovation in Imaging and the strong share that Varian holds in radiation oncology. Management has made a little more progress on improving Diagnostics than I expected, though there is still a lot of work to do. My main concern at this point is another repeat of what has been surprisingly volatile margin performance and/or evidence of weaker order patterns.

A Margin Beat (And Solid Orders) Would Be Nice In FQ3’24

I won’t say that Siemens Healthineers has been doing poorly on margins (the last quarter saw almost a point of adjusted operating margin improvement), but the last six quarters have only seen one operating income result that beat sell-side expectations and say what you wish about the value of analyst estimates, stocks still react to how a company performs relative to those expectations.

Given how the business has been trending and where the comps are, I think the company should have a decent quarter here, and I think there’s a chance for a modest margin beat. Varian seems to have put supply and logistics challenges behind it, and the comp is easy, and while comps are not easy in the Imaging or Advanced Therapies businesses, I think the former can benefit from ongoing fulfillment of past orders for higher-spec systems.

Imaging should deliver at least 6% growth, and that should accelerate over the next few quarters as the company delivers on its backlog in the U.S. A key unknown here is whether the company will pick up some tailwind in China from rolling off the anti-corruption slowdown and recent government stimulus efforts.

I don’t have high expectations for Diagnostics, but growth of 4% or more would be welcome as the company puts the surge of COVID-19 antigen testing in its past. More importantly, I want to hear about the uptake of the (relatively) new CI1900 analyzer, as this system seems to finally offer a more competitive solution to smaller labs using Danaher (DHR) or Roche (OTCQX:RHHBY) systems.

I would like to see Varian come up big, something on the order of low double-digits, given that the prior year’s performance was weak (up 7%) on logistics issues, and I’m particularly interested in what management says about trends in Japan and China.

At around 10% of revenue and segment earnings, Advanced Therapies only matters just so much, and I think more challenging comps will limit some of the upside here.

Imaging Is Looking Better And Better

I’ve been impressed with what Siemens Healthineers has achieved in its Imaging business, and I think this can still be an underappreciated growth driver for the company as new technologies drive equipment refresh cycles and perhaps some competitive takeaways.

The company’s Deep Resolve platform brings AI into MRI imaging, helping to drive faster and more accurate image construction and interpretation. I also think there’s still ample room for growth with the Magnetom Cima X 3T platform and, longer term, expanded helium-free offerings.

I’m also very interested in seeing what the uptake for Naeotom Alpha is like over the next couple of years. Photon-counting CT offers a lot of advantages, including faster procedure times (and there is almost always a line for CT imaging at hospitals), much more precise images, and lower radiation doses, and that latter point is becoming increasingly significant among healthcare providers given how common CT imaging is. This is going to be a premium offering for a while, but I expect it will eventually become the standard approach, and it could be an opportunity built on what is already something around 40% share.

Diagnostics Still Not Out Of The Hospital

Although Diagnostics has been doing a little better of late, I wouldn’t say it is doing well yet and certainly not a serious threat to the likes of Abbott (ABT), Danaher, and Roche. As I said above, I do think there is some chance that the CI1900 could take some share, but it could be a more missionary sales effort for Siemens Healthineers, as the company has a well-deserved reputation for system inferiority (weaker throughput, more hands-on time, etc.).

I still have long-term questions about the competitiveness of the company in this space. From a technical perspective, their systems have never wowed me, and I’m not sure how they can close the gap with better-established rivals. Likewise, I don’t think the company is well-placed to compete in emerging opportunities like lab-based mass spec, and the company’s weak presence in molecular diagnostics remains a limitation.

There was a rumor last year that management was exploring options for this business, and that may be a reasonable approach to take. Even in the pre-pandemic days, the margins weren’t that special (low-teens versus mid-teens at Danaher and high-teens at Roche), and the company has had persistent issues with sales coverage, product performance/features, and service – not unlike Beckman when Danaher acquired it (and spent years fixing it). Honestly, I think the company would do better by its shareholders selling or spinning this off and either reinvesting in Advanced Therapies (to build up scale) or improving the capital structure (paying down debt, etc.).

The Outlook

As I said, I’m bullish on the Imaging business given strong leading-edge products in MRI and CT, and I’m likewise bullish on Varian given further progress in areas like imaging and AI-driven imaging and planning. I also think that ARTIS icono (image guidance for a range of interventional procedures) could have more upside, particularly in stroke thrombectomy. I’m not bullish on Diagnostics, but maybe CI1900 will be more successful than I think in penetrating low-to-mid-volume labs.

I’m expecting around 5% revenue growth this year, accelerating next year as the company continues to deliver on its Imaging backlog. Longer term, I think the company can grow revenue at a 5% to 6% annual rate.

I’m expecting EBITDA margins to improve over the next three to five years toward the mid-20%’s on improved sales mix, increased services, and better profitability in Diagnostics. That should support low double-digit free cash flow margins improving toward the mid-teens over time, driving double-digit FCF growth.

Discounted cash flow suggests some undervaluation, but not a lot. Growth and margin-driven EV/revenue is more accommodating (as is usually the case), and I can argue for 10% to 20% upside on the basis of the company’s strong mid-single-digit revenue growth and 20%-plus EBITDA margin.

The Bottom Line

I do see some risks going into the next quarterly report, particularly the risks of a margin shortfall and evidence of slowing orders. Should that happen and drive a sell-off, I’d definitely consider the name. Even as is, I think there’s still enough upside here for longer-term investors to consider this as a worthwhile name.

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