Renowned value investor David Einhorn (Trades, Portfolio) and his hedge fund, Greenlight Capital, recommended Bayer (BAYRY, Financial) in November for being undervalued.
Given Bayer’s diverse businesses involving favorable patent cliff in the pharmaceutical segment, along with crop sciences, Bayer – without taking into account its proposed $66 billion acquisition of Monsanto (MON, Financial)Â – is worth more than it was priced then.
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(Have Your Cake and Eat It Too — slide 31; Greenlight Capital)
Bayer was trading at 88.8 euros ($94.89) per share at the time when it had the 11 times earnings multiple, and its shares are trading 102 euros per share or about 13 times. Still, there is roughly 50% more room to go if the average of its sum of parts multiples above, which would be 19 times, is applied.
Earnings performance
Bayer reported its interim third-quarter fiscal 2016 in October. The $90 billion drug manufacturer grew its top line by 0.4% to 34.9 billion euros and profits by 16.6% to 4.08 billion euros for its nine-month fiscal 2016 operations.
Meanwhile, Bayer saw its sales grow between 46 billion and 47 billion euros, about 0.4% growth compared to a 12% growth in fiscal 2015.
Valuations
According to GuruFocus data, Bayer ADR shares had a trailing 12-month price-earnings (P/E) ratio of 18 times (industry median 28), price-book (P/B) ratio of 3.6 times (industry median 2.9) and price-sales (P/S) ratio of 1.8 times (industry median 2.9). Bayer also had a trailing dividend yield of 2.64% with a 46% payout ratio.
Performance
Bayer ADR shares had one- and five-year total returns of 2.48% and 11.39% compared to the broader Standard & Poor's 500 index’s 23.5% and 14% (1).
(Interim Report)
Bayer
Bayer is a 153-year-old, $90 billion German multinational chemical, pharmaceutical and life sciences company. The company has core competencies in the areas of health care and agriculture. In 2015, Bayer garnered 34.4%, or 15.9 billion euros, of its total sales from Europe while 27.2% came from America and 22.2% from Asia/Pacific.
(Annual Report 2015)
In 2015, the Bayer Group comprised 307 consolidated companies in 77 countries. Bayer also had several segments including health care, pharmaceuticals, consumer health, crop science and Covestro.
Effective 2016 Bayer introduced a new organizational structure in which the health care segment had been dissolved and the company’s animal health business had its own segment. In its recent interim report, Bayer reported sales and earnings figures for Pharmaceuticals, Consumer Health, Crop Science, Covestro, Animal Health and Life Sciences (2).
(Annual Report and Interim Report)
Health Care
In Bayer’s 2014 annual report, the health care segment specialized in the area of prescription medicines and consumer products. The health care subgroup researches, develops, manufactures and markets products to improve the health of people and animals.
Excluding all other segments and corporate center and consolidation addendums, health care sales grew 20% and contributed 34%, or 22.9 billion euros, in total Bayer sales in fiscal 2015. The health care segment also had earnings before interest and taxes (EBIT) margin of 17.7% in the period.
Pharmaceuticals
In its 2015 annual filing, Bayer’s pharmaceuticals division focused on prescription products, especially for cardiology and women’s health care and on specialty therapeutics in the areas of oncology, hematology and ophthalmology. The division also comprises the radiology business, which markets diagnostic imaging equipment together with the necessary contrast agents.
In fiscal 2015, three pharmaceutical products contributed more than 1 billion euros to Bayer’s total sales. Xarelto, Eylea and Kogenate provided sales of 2.25 billion euros, 1.23 billion euros and 1.16 billion euros while growing at 34.1%, 61.8%, and 4.1%.
Xarelto is marketed in the U.S. by Johnson & Johnson (JNJ, Financial). It is being used for several medical conditions including treatment for deep vein thrombosis, a condition in which a clot in a deep vein could further result in a stroke or pulmonary embolism.
Xarelto’s active ingredient patent expires in 2020 while the drug’s formulation patent expires in 2024.
Eylea is marketed in the U.S. by Regeneron Pharmaceuticals (REGN, Financial) exclusively. Eylea is approved for the treatment of wet age-related macular degeneration, visual impairment due to macular edema secondary to central retinal vein occlusion and diabetic macular edema.
Kogenate is a medicine used to replace the clotting factor (factor VIII or antihemophilic factor) that is missing in people with hemophilia A. Kogenate’s drug formulation patent expired in 2016.
Excluding all other segments and corporate center and consolidation addendums, pharmaceuticals sales grew 14% and contributed 20%, or 13.7 billion euros, in total Bayer sales in fiscal 2015. Pharmaceuticals had an EBIT margin of 20.4%.
Nine months into fiscal 2016, pharmaceutical sales grew 7.3% while delivering an EBIT margin of 22.9%.
Consumer Health
The Consumer Health Division markets mainly nonprescription products in the dermatology, dietary supplement, analgesic, gastrointestinal, cold, allergy, sinus and flu, foot care, sun protection and cardiovascular risk prevention categories.
These products include globally known brands such as Claritin™, Aspirin™, Aleve™, Bepanthen™/Bepanthol™, Canesten™, Dr. Scholl’s™1 and Coppertone™
In fiscal 2015, consumer health grew 30% and contributed 13%, or 9.1 billion euros, in total Bayer gross sales (excluding all other segments and corporate center and consolidation addendums). The segment also provided a 13.6% EBIT margin.
Nine months into fiscal 2016, the Consumer Health Division had a negative 1.6% change in sales to 4.5 billion euros and delivered 13.9% EBIT margin.
Crop Science
The Crop Science Division has businesses in seeds, crop protection and nonagricultural pest control. It is organized into two operating units: Crop Protection/Seeds and Environmental Science.
Crop Protection/Seeds markets a broad portfolio of high-value seeds along with innovative chemical and biological pest management solutions while at the same time providing extensive customer service for modern and sustainable agriculture.
Environmental Science focuses on nonagricultural applications with a broad portfolio of pest control products and services designed for applications ranging from the home and garden sector to forestry.
In fiscal 2015, Crop Science grew 9.2% and contributed 15%, or 10.4 billion euros, in total Bayer sales, excluding addendums as mentioned above. The division also delivered a 20.3% EBIT margin.
Nine months into fiscal 2016, the Crop Science segment had a 2.7% drop in sales to 7.5 billion euros and delivered an EBIT margin of 21.3%.
Animal Health
The Animal Health Business Unit offers products and services for the prevention and treatment of diseases in companion and farm animals.
In fiscal 2015, animal health business grew 13% to 1.49 billion euros and delivered an EBIT margin of 17%. Nine months into fiscal 2016, animal health sales grew by 2% to 1.19 billion euros and delivered an EBIT margin of 24% – highest margin among all of the Bayer’s subgroups in its recent filing.
Covestro
Covestro (XTER:1COV, Financial) is a leading supplier of high-tech polymer materials and develops innovative product solutions for a wide variety of everyday uses. According to Reuters, Covestro is a Germany-based company engaged in the manufacture of plastic materials. Covestro was a spinout from Bayer in 2015. Bayer owned around 69% of Covestro as of fiscal 2015.
In fiscal 2015, Covestro sales grew by 2.8% to 11.98 billion euros while delivering an EBIT margin of 5.3%. Nine months into fiscal 2016, Covestro sales had a negative 4.1% change in its sales down to 8.8 billion euros from 9.2 billion euros the year prior while delivering an EBIT margin of 12.5%.
Overall, Bayer had five-year sales, profit and operating margin averages of 5.7%, 25.9% and 10.4% (1).
Cash, debt and book value
As of its third quarter report, Bayer had 1.23 billion euros in cash and cash equivalents and 18.93 billion euros in financial liabilities with a financial liability to total equity ratio of 0.76, compared to 0.769 in December 2015.
Bayer also had 39% of its 76.5 billion euros assets in goodwill and intangibles with a book value 24.8 billion euros compared to 22.6 billion euros the year prior.
Cash flow
(Interim report, Bayer)
Nine months into fiscal 2016, Bayer grew its cash flow from operations by 26.8% to 5 billion euros. In addition to improved profits, Bayer also saw less cash outflow from its accounts payables and inventories but had more cash outflow on its accounts payable during the period.
Capital expenditures were 1.6 billion euros, similar to the year prior, leaving Bayer with 4.75 billion euros compared with 3.4 billion euros the year prior. Bayer allocated 44.7%, or 2.1 billion euros, in dividends in comparison to 47% average in the past two fiscal years.
(Interim Report and Morningstar data)
Bayer also took in 12.1 billion euros in debt but retired 12.7 billion euros in the same period.
Conclusion
Bayer’s extensive corporate history in life science businesses, including animal health care, gives the company a default moat rating.
Defining each of the company’s segments’ progress in recent years was difficult secondary to restructuring. It appeared that Bayer had been able to continuously grow its top line figure and able to squeeze more profits from its operations brought down by control in operational costs. Bayer had improved its operating margins to 11% in its fiscal 2015, compared to just 8% in fiscal 2012.
Additionally, dividend payouts are to be well taken care of secondary to Bayer’s bountiful free cash flow. On the other hand, goodwill/intangibles and leverage found in Bayer’s balance sheet may deter conservative investors.
Historical earnings multiple applied to historical profit growth average with a 20% margin gave a value of 119 euros a share (or $127 a share at today’s exchange rate).
(Bayer ADR shares at $108.5 a share and a ttm earnings multiple of 17 times; GuruFocus)
At today’s share price, Bayer is definitely still undervalued compared to its historical earnings multiple and business growth minus any Monsanto acquisition.
In summary, Bayer is a buy with a target price of at least $130 a share, representing a near 20% upside.
Notes
(1) Morningstar data.
(2) Annual report: With the company’s focus now on the life science businesses, a new organizational structure was introduced effective Jan. 1, 2016. The company’s operations are now managed in three divisions – Pharmaceuticals, Consumer Health and Crop Science – and the Animal Health business unit. The former Bayer HealthCare subgroup has been dissolved. The Radiology and Pharmaceuticals businesses have been merged to form the Pharmaceuticals Division. The Consumer Health Division now consists entirely the consumer care business. Animal Health has become a separate reporting segment. The Bayer CropScience subgroup is now the Crop Science Division. The former MaterialScience subgroup, renamed Covestro, became legally and economically independent on Sept. 1, 2015. Covestro was floated on the stock market on Oct. 6, 2015. Bayer currently still owns around 69% of Covestro. Covestro therefore remains a reporting segment of the Bayer Group because Bayer continues to exercise control.
(3) Annual report: Xarelto™ (active ingredient: rivaroxaban) has been approved for more indications in the area of venous and arterial thromboembolism than any of the other nonvitamin-K-dependent oral anticoagulants. Xarelto™ is approved in more than 130 countries worldwide across all indications, its approval status varying from country to country. Xarelto™ is marketed in the U.S. by Janssen Pharmaceuticals, Inc., a subsidiary of Johnson & Johnson. In May 2015, Xarelto™ was approved by the China Food and Drug Administration (CFDA) for the prevention of stroke and systemic embolism in patients with nonvalvular atrial fibrillation and for the treatment of deep vein thrombosis (DVT). The approval also includes the use of Xarelto™ to reduce the risk of recurrent DVT and pulmonary embolism following acute DVT. In September 2015, Xarelto™ was approved by the Japanese Ministry of Health, Labor and Welfare (mhlw) for the treatment and secondary prevention of pulmonary thromboembolism and deep vein thrombosis. In addition to the already approved indications, the use of rivaroxaban is also being investigated in other cardiovascular diseases such as prevention of major adverse cardiac events, embolic stroke of undetermined source or peripheral artery disease. Rivaroxaban was invented by Bayer and is being jointly developed with Janssen Research & Development LLC, U.S., a subsidiary of Johnson & Johnson.
Disclosure: I do not have shares in any of the companies mentioned, but have initiated a limit order on Bayer shares by market open.
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