In June 2020, I discussed Signify (OTCPK:PHPPY) (OTCPK:SFFYF) as this lighting company, which was a spin-off of Philips (PHG) was working on a UV-C light that killed 99% of the the COVID-19 virus in a few seconds. The technology is now rendered somewhat obsolete as the initial panic reaction surrounding COVID-19 is over, but UV-C lighting is obviously still widely used, for example to sterilize operating rooms, which was also the main application before COVID. As annual capital expenditure is quite low, Signify has always been a cash cow and the company’s share price has rebounded from less than EUR 22 per share in June 2020 to a high of nearly EUR 55 per share. stock in the summer of last year before losing around 50% of its value again. A real rollercoaster and I wanted to check if it might be a good idea to buy shares around the current share price level of 26 EUR per share.
The company’s main listing on Euronext Amsterdam is much more liquid, with around 575,000 shares traded daily. The current market capitalization is approximately €3.25 billion based on 125 million shares outstanding. Signify was once an avid buyer of its own stock, but a $1.4 billion acquisition a few years ago led to a shift in priorities toward debt reduction and balance sheet strength. Signify is still buying back shares, but at a slow pace, and only to cover option plans.
Real estate sales will contribute to this year’s reported free cash flow
Signify’s main activity obviously remains everything related to lighting. And it is not only the production of bulbs or LED lamps, but also solutions for professional environments, such as the use of UV-C lamps to sterilize parts and equipment (because UV-C radiation breaks down the DNA of microorganisms).
Signify is definitely feeling the impact of the Ukrainian-Russian war and lockdowns in China this year, as these elements had a negative influence on the second and first half results. The company was obviously hit by inflation and supply chain issues in the first half of this year, but when it announced its second quarter results in August, it mentioned that it expected that headwinds on margins are easing in the second half, which is encouraging. .
Signify recorded total revenue of just over €3.6 billion, an increase of almost 13% compared to the first half of last year. As expected, COGS increased at a faster rate (more than 15%) leading to an increase in gross margin of only 5% to 1.33 billion euros. That’s obviously still pretty good, and I was pleasantly surprised to see the relatively small increase in SG&A and R&D spending (both up about 1%).
Operating profit soared, but this was entirely related to “other business income” which included the one-time gain on the sale of real estate assets. Signify sold real estate for approximately 194 million euros while the book value of these assets was only a few million euros because they had already been almost completely depreciated over the past few years.
This obviously also boosted pre-tax income and post-tax income which amounted to €335 million, of which €332 million was attributable to Signify shareholders. Considering that there are approximately 125 million shares outstanding, the net profit per share was approximately EUR 2.66. But of course, the increase in net income is entirely due to the appreciation on real estate assets.
In 2020, I based my investment thesis on Signify’s cash flow profile and traditionally very low investments, so it’s fair to judge Signify again based on its cash flow profile. Operating cash flow reported in the first half of the year was negative at 191 million euros. But as you can see below, this was entirely caused by a build-up of €486m in the working capital position. You’ll also see that the total tax burden was only €46 million, and I’ll keep that figure unchanged as I want to determine the free cash flow that Signify generates excluding the one-time asset sale.
Thus, on an adjusted basis, cash flow from operations before changes in the working capital position was approximately EUR 295m (including cash payments to the pension fund and use of provisions). This is almost exactly the same result as the EUR 291m in the first half of 2021. Total capex in the first half of this year was EUR 57m (of which EUR 26m was spent on intangibles), which which gave rise to a net result of free cash flow of 238 million euros. Spread over the 125 million shares outstanding, the underlying free cash flow in the first half of the year was approximately EUR 1.90 per share, and this excludes the gain on the sale of real estate assets and changes in working capital.
At the end of June, the company had a positive working capital of approximately 840 million euros. The balance sheet also contained €407 million in cash while there is approximately €2.15 billion in financial debt, giving a net debt level of €1.75 billion.
Net debt increased due to changes in working capital as well as the nearly €300 million Signify spent on acquisitions. This should have a positive impact on the remainder of this year and as I expect EBITDA for the full year to exceed 800 million and possibly even closer to 900 million at 1 billion euros if Signify can indeed improve its margins again, the net debt level does not bother me because the debt ratio remains well below 2.
Dissecting the official outlook for this year
For the full year, Signify expects comparable sales growth of 3-6%, but reduced its adjusted EBITA margin (excluding depreciation charges) by 11-11.4% due to the slowdown of the second quarter of this year.
For the full year, Signify expects free cash flow to be 5-7% of total revenue, including the cash contribution from the sale of real estate assets. Assuming full-year revenue of €7.5 billion (from €3.6 billion in the first half), the free cash flow result will be €375-525 million. euros, of which 195 million euros will come from asset sales. This means that the underlying free cash flow will be 180 to 330 million euros. This is still a very broad guidance, and I expect to see Signify narrow it when it reports Q3 results.
Investors are cautioned that Signify’s guidance includes changes in the position of working capital, so it’s a bit difficult to base investment decisions on the official guidance as we don’t know exactly how working capital will fluctuate.
The longer-term objective is to return to an 8% free cash flow margin based on revenue as soon as supplier lead times ease. Sounds good, but since the global economy is a little fragile, I think Signify will need a few more years to hit that 8% mark. And while this still includes changes in working capital, these WC investments are expected to decline over time and the underlying free cash flow will be fairly close to the reported free cash flow.
But if Signify were indeed to hit that 8% margin on what will be €8 billion in annual revenue once the acquisitions are fully digested, the forecast implies a free cash flow result of over €640 million. euros, i.e. more than 5 euros per share. If Signify is indeed able to deliver on this promise, Signify is currently trading at a forward free cash flow yield of 20%, so the current free cash flow yield is definitely sustainable.
Once the uncertainty surrounding supplier lead times improves, I expect Signify to reinvigorate its share buyback program. The shares are trading quite cheaply as the H1 FCF result was already close to EUR 2 per share and H2 could perhaps be slightly better. And just to avoid any seasonality issues: adjusted free cash flow for fiscal years 2020 and 2021 was EUR 553m and EUR 588m respectively, which translates to EUR 4.42 and EUR 4.70 per share. This means that even when the stock was trading in the mid-50s, it was actually not outrageously expensive.
I think it might be interesting to start building a position again at Signify. The company paid a dividend of EUR 1.45 based on its results for the financial year 2021, which represents a dividend yield of 5.5%, which is a nice compensation for waiting for the price of the action is picking up.
There is no urgency, but weakness could be opportunities.