Philips Needs A Shake-Up

By Stephen D. Simpson, CFA | June 23, 2011 AAA

Although Dutch conglomerate Philips (NYSE:PHG) has bounced off the late 2008/early 2009 bottom in the stock, it has been many years since Philips was really a credible candidate for a long-term investor. Once an unquestioned leader in lighting and a strong competitor in consumer electronics, Philips has fallen victim to the bloat and malaise that seems to affect almost every conglomerate sooner or later. The question for investors now, though, is how long they are willing to wait for real signs of a new way of doing business at this company.

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Weak Guidance Hamstrings the Stock
Philips surprised the market by preannouncing a disappointing second quarter. Management was sparse on details, but sales in the core lighting business only grew in the low single digits, while sales in consumer electronics have fallen from last year's level on weakness in Europe and a restructuring of the TV business.

Oddly, the company said nothing about the health care business, which is a substantial factor in sales and profits. That said, based on the performance at competitors like General Electric (NYSE:GE), Siemens (NYSE:SI), Varian (NYSE:VAR), Hologic (Nasdaq:HOLX) and ZOLL (Nasdaq:ZOLL), it would seem credible that Philips had a good, but probably not spectacular, quarter.

All in all, then, it is hard to forecast just what sort of numbers Philips might report. That may be part of the reason behind the harsh reaction in the stock market (which sent the stock down 10% after the announcement). More to the point, it's an incredibly sloppy move on the part of management to basically yell "Fire!" without following up with details.

Can Philips Make These Assets Work?
If Philips wants to enjoy a turnaround comparable to that of Siemens, the company has some work to do. Lighting, for instance, has turned into a tough business as the transition to LED has not quite worked out as expected for Philips, Siemens, General Electric or Cree (Nasdaq:CREE). While Philips continues to spend large sums of money in R&D, its large conglomerate rivals seem to be more focused on stripping costs out of existing technology. (For related reading into R&D, see Buying Into Corporate Research & Development (R&D).) It is also worth noting that Siemens is looking to spin off Osram - not exactly a vote of confidence for the lighting market.

If maintaining profitable leadership in lighting has proven difficult, consumer electronics risks becoming an albatross. More and more, Philips seems to find it hard to compete with Asian rivals like Samsung, LG, Funai, Sharpe, Sony (NYSE:SNE) and Techtronic (Nasdaq:TTNDY). Philips has a great history here, including being on the leading edge of technologies like CDs, DVDs, and Blu-Ray, and growth in areas like Personal Care has been solid, but the overall business has struggled to hold up against rivals with better cost structures.

Waiting For the Real Restructuring
Siemens was once in a position not all that dissimilar to Philips and plenty of investors wrote it off as hopeless. Fortunately for the company, they tapped the right people for senior management, made some tough choices, and started demanding better performance from their units. The result has been a very solid market performance in recent years.

This could happen for Philips too, but the emphasis has to be on "could" at this point. Philips hired a CEO (van Houten) with a reputation as a restructuring specialist, but there have been rather few details about whether Philips is going to get its house in order. More than anything, the company needs to balance the brand rewards of being a technology and innovation leader with the economic realities of returns on capital. This will entail more than just firing people and looking to wring costs of the system; if Philips does not lay out a vision to fundamentally transform its operating philosophy, there is no reason to own the stock other than as a value trade.

The Bottom Line
Absent that new vision for the company, there is no compelling reason to own Philips stock today. The company is cheap relative to its prospects, but there has to be serious doubt in the mind of rational investors about whether the company can realize the value of those prospects. For now, then, Philips is a wait-and-see and a ripe candidate for a solid turnaround plan.

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