SMMNY - Siemens Healthineers: Robust Equipment Demand But With Some Ongoing Internal Challenges

Summary

• Hospital capital spending demand is strong, but Siemens Healthineers posted a small yet broad miss across its major business units for the fiscal first quarter.
• Imaging is performing well and Varian and Advanced Therapies were compromised by supply chain challenges, but core underperformance in Diagnostics is an ongoing issue.
• New launches in Imaging should drive attractive revenue growth, and Varian remains far and away the leader in radiation oncology, but Diagnostics needs more TLC.
• Siemens Healthineers shares look 15% to 25% undervalued today.

Like many of its peers in diagnostics and imaging, Siemens Healthineers ( SMMNY ) didn’t have the greatest share price performance in 2022 and the stock is down about 13% since my last update on the company – comparable to the performance of the broader med-tech market and superior to the results from Abbott ( ABT ) and Roche ( RHHBY ), but not as strong as the results from Hologic ( HOLX ).

I can understand some concern about the growth potential of the long-lagging Diagnostics business now that COVID-19 antigen testing is going away, and I can likewise appreciate that a couple of weak quarters from Varian would be a concern. Still, core equipment order growth remains strong and the Varian issues appear temporary (and largely resolved). Improved results from Diagnostics should be a priority, but I find these shares still offer some potential at today’s price.

A Broad-Based Miss Doesn’t Help The Bull Case

The results from Siemens Healthineers’ fiscal first quarter weren’t too wide of the mark, but pretty much every business missed and while guidance for FY’23 was fine, there definitely seems to be a preference for more therapeutics/disposables-driven stories in med-tech right now.

Revenue declined about 4.5% in organic terms, missing by about 2.5%. Growth excluding COVID-19 antigen tests was a little shy of 1%. Every segment missed sell-side expectations, with Imaging up 5% (missing by 1%), Diagnostics down 24% (or 7% ex-antigen tests), missing by 4%, Advanced Therapies up 5% (missing by 1%), and Varian down about 5% (missing by 9%).

Gross margin declined 100bp yoy and about 200bp qoq to 36.6%, with the company seeing supply issues in the Advanced Therapies and Varian businesses in particular, but also seeing cost inflation across the business. Adjusted operating income declined 28% in the quarter, missing by more than 2%, with margin down five points to 12.7%.

Imaging profits rose 15%, beating by 1% (with margin up 110bp to 20.9%), while Diagnostics dropped precipitously (missing by 36%) even accounting for restructuring costs, as the company annualized very profitable COVID-19 test sales and encountered supply, forex and end-market headwinds. Advanced Therapies profits declined 11%, missing by 8%, with margin down 260bp to 11.6%. Varian profits declined 18%, missing by 7%, with margin down 350bp to 14.5% on supply shortages.

Underlying Demand Remains Healthy

Capital equipment demand has been surprisingly robust across the sector, and Siemens Healthineers logged 16% year-over-year growth in orders, finishing the quarter with a 1.36x book-to-bill. Guidance for the next year was also positive. While headline reported revenue is likely to be flattish due to difficult pandemic testing comps, underlying revenue growth excluding those tests should be in the 6%-8% range, with stronger growth in Imaging and Varian and weaker results in Diagnostics.

I continue to like the leverage this company has across a range of therapeutics categories. The Magnetom Free.Max continues to offer opportunities to extend Siemens’ already-strong leadership position in MRI by allowing installations in locations that couldn’t previously support an MRI machine, while the new Magnetom Cima offers improved imaging accuracy for more conventional bunkers.

On the CT side, I’m still excited about the potential of the Naeotom CT and its new quantum photon-counting system. Patient lifetime radiation exposure is becoming a more and more significant topic in imaging, and this is exactly the sort of system that addresses that concern (as much less X-ray exposure is required).

With Varian, I’m not sure that the new HyperSight is really a needle-mover. Improved contrast and spatial resolution is great, and the faster image acquisition time is a definite plus (six seconds versus 60 seconds), but I don’t see how this puts Varian machines into bunkers that don’t already use Varian. I’d be more interested in hearing about what the company wants to do to target markets like China more effectively.

Beyond the near-term drivers, I think Siemens Healthineers management is generally focusing on the right things. There’s an enterprise-wide emphasis on automation that I think is smart in view of ongoing healthcare labor challenges, and I also like the focus on improved tools for more complex cases, like the Artis Icono motorized C-arm for complex procedures like aneurysm repair and Corindus for stroke. Management has also talked about investing in technologies for patient twining, which would allow clinicians to visualize organs digitally and simulate physiological reactions to various treatment approaches.

Diagnostics Needs A Stronger Prescription

Siemens Healthineers’ Diagnostics business has been a problem child for a while, and nothing is really changing. The company got a boost from the pandemic, but management is now launching a broad restructuring effort that includes portfolio simplification, footprint reduction, new go-to-market strategies, supply chain cost reductions, and leaner R&D.

Unfortunately, I don’t see these strategies as fixing the core issues in the business. Siemens has lagged peers and rivals like Abbott, Danaher ( DHR ), Hologic, and Roche due to less impressive automation and product features (weaker throughput, worse time-to-result, more hands-on time, etc.), a less impressive menu of tests, and weaker sales coverage and service. I don’t see any of management’s proposed changes really fixing these issues. What I think management should do is take a page from Danaher’s playbook, as that company once had similar issues in its diagnostics business and addressed them largely through improved product performance, improved support, and improved customer engagement.

It’s not all bad here, though. First, the company has a large enough installed base that it is still very much a fixable situation. Also, I do like the company’s shift toward areas that aren’t as well-served by competitors – including more early-stage cancer detection testing and a new non-invasive blood test to assess the risk of progression to cirrhosis in patients with non-alcoholic fatty liver disease. Given the number of treatments in development for NASH (non-alcoholic steatohepatitis), this should be a growth opportunity across many years.

The Outlook

As the company moves past the pandemic-inflated comps, I think the core growth potential in the high mid-single-digits (6%-7%) will get more attention later in 2023 and into 2024. Long term, I’m expecting core adjusted revenue growth of over 5%, with Varian and Imaging leading the way. While I don’t expect the company to pivot more into therapeutics, there are a lot of opportunities within Advanced Therapies to support/facilitate growth in more complex coronary, endovascular, and oncology procedures.

It will be hard to offset the lost profits from high-margin COVID-19 antigen tests in the near term, but I do expect EBITDA margin to improve from 20% to 23% over the next five years after a step down in FY’23. The restructuring in Diagnostics should help, but I expect more impact from the ongoing launches/growth of new MRI and CT systems and Varian. Long term, I expect free cash flow margins in the mid-teens to drive high single-digit FCF growth.

Between discounted cash flow and growth/margin-driven EV/revenue, I believe Siemens Healthineers shares still offer upside. Discounted cash flow suggests a long-term annualized potential return in the high single-digits, while growth and margins support a 3.75x forward revenue multiple and around 25% upside from here.

The Bottom Line

I am concerned about the ongoing challenges at Diagnostics and whether management really understands the key issues holding the business back. I also have some concerns about market sentiment, as capital equipment stories may be a harder sell in a slower global economy (despite Siemens Healthineers’ strong orders). Even with those concerns, though, I do think the share price doesn’t fully reflect the quality and potential of the business, and I think this is a name worth further due diligence.

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