As much as investors may want to consider themselves as long-term owners, the reality is that short-term company performance still matters, and nobody likes to see their portfolio holdings decline. I mention this at the open of this discussion of GE HealthCare Technologies (NASDAQ:GEHC) because I do see a split between a riskier near-term outlook that is dependent upon a strong second-half performance and a longer-term outlook that may undervalue some significant growth drivers within the business.
GE HealthCare looks undervalued enough that I worry that I’m missing something or taking too bullish of a view toward the company’s growth potential. I can argue for a fair value in the low-to-mid-$90’s, and even over $100 by some metrics, but investors clearly don’t feel the same at this point. I don’t love the fact that GEHC is playing catch-up in areas like photon-counting CT, and margins need to get better, but I’m also excited by the potential of the company’s Pharmaceutical Diagnostics (or PDx) business, with leverage to opportunities in Alzheimer’s, cardiology, and cancer.
A Strong #2 In Imaging, But Margins Have To Improve
Siemens Healthineers (OTCPK:SMMNY) is comfortable on top in the imaging space with close to 40% share, but GE HealthCare is a strong #2 with over 20% share across MR, CT, X-ray, molecular imaging, and women’s health and over 30% share in some particular markets.
I like GEHC’s breadth of offerings, as there really aren’t any major areas of imaging where the company doesn’t compete, and I believe areas like molecular imaging and image-guided therapeutics are well-situated for ongoing growth. I also like the fact that while this is a capex-heavy business, about 40% of revenue is still recurring, with close to half of that coming from service contracts.
Speaking of capex, I think the Street too often frets about how reliant imaging businesses like Siemens Healthineers, GEHC, and Philips (PHG) may be on hospital capital budgets. It is true that imaging is now a cost center with the move from fee-for-procedure to bundled reimbursement, but it’s also true that imaging is a critical offering. Performing procedures without adequate imaging increases failure rates, and insurers now typically won’t reimburse for readmissions within 30 days. Moreover, having adequate imaging facilities is pretty much mandatory if a center wants to retain quality physicians.
While I am not overly concerned about capex budgets (though I admit they can cause short-term volatility), I am a little concerned about GE’s lagging position in photon-counting CT. This is a big step forward in CT imaging, allowing for much sharper images (2x better) with less radiation. Siemens Healthineers has been in the market with a photon-counting CT system for a while now, but GEHC is still a few years away.
I don’t necessarily think that GEHC is going to permanently lose business, but I do think the lack of a photon-counting offering will be a headwind. Longer term, I expect the company to catch up and perhaps even surpass Siemens Healthineers. GEHC has chosen to go with silicon detector technology (vs cadmium zinc telluride at Siemens Healthineers), and while silicon has upfront challenges because it collects fewer photons, GEHC is using an “edge on” approach for its sensors and silicon can offer advantages like increased resolution, reduced noise, and cost-effective manufacturing.
Last and by no means least, I want to see GEHC improve its margins within imaging. The company trails Siemens Healthineers by a noticeable amount; even if I fold in GEHC’s Ultrasound business (which Siemens Healthineers includes in Imaging), margins are in the low-teens (around 13%) versus over 20% at Siemens Healthineers. Neither company offers enough information for me to get to the heart of why this should be; GEHC may be spending more on R&D (to catch up) or it may have more fundamentally inefficient manufacturing and distribution. Whatever the cause, it’s a must-improve item for management.
Growth Opportunities, Particularly In PDx, Could Be Worth More Than Seems To Be In The Stock Price
Given that I follow Siemens Healthineers and Philips at least somewhat regularly (need to get on that next Philips article…), I was going to write about GE HealthCare sooner or later. What has surprised me, though, is the extent to which the Street doesn’t seem to care about some of the growth opportunities within the business that could drive better margins and revenue in the not-so-distant future.
In Ultrasound, GEHC is starting to see increased use of ultrasound imaging in surgery for visualization and guidance, as well as point-of-care treatment. Both of these could drive high single-digit to low double-digit growth in markets already worth around $1B each. Better still, with Ultrasound already producing good margins for GEHC, the incremental margins on this growth should be attractive.
GEHC also has a new collaboration (the announcement was in October of 2023) with Novo Nordisk (NVO) to develop non-invasive treatments for obesity and Type 2 diabetes that will center around peripheral-focused ultrasound technology (or PFUS). This is a much more speculative opportunity, but the upside (if it works) could be significant.
What really interests me now, though, is the PDx business. This is the business that develops and manufactures contrast media and radiopharmaceuticals for imaging, and I see opportunities in Alzheimer’s, cardiology, and cancer that are worth noting.
For Alzheimer’s, GEHC has an opportunity to leverage prescription growth for Leqembi (sold by Biogen (BIIB) and Eisai (ESAIY)), as the label requires four MRI scans during diagnosis and monitoring, as well as PET scans in diagnosis and monitoring. Not only might this drive incremental MR and PET scanner sales, but it will also drive incremental sales of Vizamyl, the company’s tracer for Alzheimer’s.
The cardiology opportunity is even larger. Flurpridaz is a new PET radiotracer for myocardial perfusion imaging that has shown significant promise in two pivotal studies. Flurpridaz offers better resolution (it has a shorter positron range than Rb-82), and this allows for more accurate quantification of blood flow as well as the detection of perfusion defects that might otherwise go unnoticed. It also has a longer half-life (110 minutes), which means that it can be produced regionally and transported to hospitals that don’t have cyclotrons, and it can also be used in stress tests.
There are an estimated 9 million or so perfusion tests done annually, but only about 1M are done with PET because of the current limitations of the radiotracers used. With the advantages of Flurpridaz, it could triple the market, generating $1.5B or more in incremental revenue opportunities for GEHC.
Last and not least is oncology. PET scans are already routinely used in many cancer cases, but GEHC has a pipeline of new radiopharmaceuticals targeting things like estrogen and Her2 receptors (relevant to breast cancer) and CD8, which can help doctors determine much more quickly whether a patient is responding to targeted therapy. Along similar lines, the company has a licensing agreement with SOFIE Biosciences to develop tracers targeting fibroblast activation protein (or FAP), which is highly expressed in cancer-associated fibroblasts.
With a growing number of more finely targeted cancer therapies on the market and in the clinic, I see a large market opportunity in radio-tracers that can help identify those patients more likely to respond to a specific therapy and/or determine a treatment’s efficacy earlier in the process, thus likely giving physicians and patients more options.
The Outlook
As I said, there are near-term challenges. Orders have been sluggish of late (up 1% in the last quarter), and the backlog declined about 2% sequentially in the last quarter. The China business has been hurt by tough comps and some fallout from the corruption investigations (which led to pauses in capital spending), and management’s guidance for FY’2024 calls for a meaningful upswing in the second half of the year that may be challenging to achieve, particularly given tougher comps.
While not wanting to underplay the near-term risk and the sensitivity of the stock price to disappointing quarters/guidance (the shares dropped 14% with Q1’24 earnings), I do still see a pretty healthy long-term outlook. I’m looking for revenue growth on the higher end of 4% to 5% over the long term, and I do expect margins to improve meaningfully – from around 17% last year (EBITDA) to over 18% this year, over 19% in FY’26, and toward 20% in five years.
GEHC still isn’t optimized to run as a standalone company, so I think there’s room to improve the manufacturing and distribution efficiency, as well as exit TSAs, while also benefitting longer term from the launch and growth of higher-margin products (including very high-margin radiopharmaceuticals). Long term, I think free cash flow margins can move into the low double-digits (still a few points below Siemens Healthineers), generating high single-digit FCF growth.
M&A is also a potential driver. I don’t expect large-scale deals from the company, but I do think it will look for tuck-in deals to fill gaps and/or add attractive offerings in areas like Patient Care and PDx. GEHC does have a marketing alliance with Accuray (ARAY) and if that company is successful with its relatively new China-focused radiation oncology products, it’s possible GEHC could look to enter the rad-onc treatment market; I don’t think this is likely, as competing with Siemens Healthineers’ Varian is not a simple task, but it is possible.
GE HealthCare shares look undervalued to me on both discounted cash flow and margin/growth-driven EV/revenue and P/E, with a fair value range between the mid-$80’s and $108.
The Bottom Line
I do think that GEHC faces meaningful competition in its major markets from companies like Siemens Healthineers, Philips, Hologic (HOLX) and others, and I do think the company’s margins are not where they need to be. At the same time, I see avenues to improve these margins and I also think there is underrated growth potential in the PDx business. I am concerned that FY’24 guidance is too high and that a revision could lead to another sharp selloff, but below $90 I think these shares have long-term appeal.
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