BAYZF - Bayer: Disappointing Outlook Doesn't Change The Deep Value Thesis

Summary

• Bayer delivered strong FY 2022 results, beating analyst consensus estimates with regards to both topline and earnings.
• However, markets punished the stock lower following the earnings release, due to a perceived weak 2023 outlook.
• But investors should consider that EPS projections of between EUR 7.2 and EUR 7.4 imply a continuation of strong demand.
• Bayer's cheap valuation would only be justified if either Bayer's market would contract, or Bayer's competitive strength would diminish--both unreasonable assumptions.
• Reflecting on ongoing structural tailwinds, as well as a super cheap valuation, I am confident to reiterate a bullish recommendation.

Thesis

Bayer ( OTCPK:BAYRY ) closed FY 2022 reporting solid Q4 results, beating analyst consensus estimates with regards to both revenue and earnings. However, the 2023 outlook pressured sentiment in the trading session following the results announcement, with Bayer stock trading lower by as much as 5% (Xetra listing reference).

Investors should consider, however, that Bayer's 2023 profitability guidance is only marginally below 2022 metrics. And with estimated FY 2023 earnings of about EUR 7.4 per share, investors continue to undervalue Bayer's earnings power, in my opinion. That said, although I slightly adjust my EPS estimates through 2025, I continue to calculate more than 100% upside for the German life sciences conglomerate. Bayer remains a 'Strong Buy'.

Strong Q4 and 2022 Results

Bayer reported solid Q4 results, comfortably topping consensus estimates with regards to both sales and earnings. During the period from September to end of December, Bayer generated group revenues of EUR 12 billion, an increase of close to 8% as compared to the same year prior, and about EUR 450 million above analyst consensus estimates (according to data collected by Bloomberg). Similarly, Bayer's profitability expanded attractively: for the respective period, Bayer's EBITDA before special items grew to EUR 2.46 billion, and EPS increased to EUR 1.35.

For the FY 2022, Bayer group sales increase by about 8.7% on a FX adjusted bases, to EUR 50.74 billion. With regards to profitability, EBITDA before special items jumped 20.9%, to EUR 13.51 billion, and earnings per share increased 22% to EUR 7.94 respectively.

Anchored on strong cash flow and an improving balance sheet -- Free cash flow in FY 2022 increased to EUR 3.11 and net financial debt fell to EUR 31.81 billion -- Bayer management opened the discussion for higher shareholder payouts, proposing to increase dividends by 20% as compared to 2021, to EUR 2.4/share.

All Operating Units Perform

Notably, Bayer's strong FY 2022 results were supported by all of the group's operating segments.

The Crop Science division recorded strong revenue growth and accumulated record EBITDA. As compared to 2021, sales increased 25% YoY, to EUR 26.2 billion and EBITDA surged by 46% YoY, to EUR 6.9 billion.

The Pharmaceuticals unit expanded topline by 5% and EBITDA by 2%, growing to EUR 19.3 billion and EUR 5.9 billion respectively.

The Consumer Health unit recorded a 15% YoY jump in net sales, growing to EUR 6.1 billion, while EBITDA also expanded by about 15%, to EUR 1.4 billion.

Looking Beyond The Disappointing 2023 Outlook

Bayer management guided for a somewhat muted 2023 profitability (emphasis added):

Following two consecutive years of high single-digit percentage growth rates, we expect our business to remain at a high level and grow by two to three percent in 2023 on a currency- and portfolio-adjusted basis

The company anticipates lower prices for agricultural herbicides as well as for some of its established pharmaceutical products. Projected sales growth in the other parts of the portfolio and from new products are expected to have a positive impact. As regards earnings in 2023, growth-driven margin contributions and positive effects from ongoing efficiency programs will not be sufficient to offset the anticipated decline in prices as well as high inflation-driven cost increases , which are expected to continue.

In financial terms, Bayer expects to generate revenues of between EUR 51 billion to EUR 52 billion. EBITDA before special items is expected between EUR 12.5 billion to EUR 13.0 billion earnings per share will likely fall in the range of EUR 7.20 to EUR 7.40.

With respect to the divisions, Bayer expects its Crop Science unit to materialize sales growth of about 3%, while its Pharma division is projected to grow by around 1%, and Consumer Health is anticipated to grow by approximately 5%.

Although the outlook is somewhat disappointing, certainly below respective FY 2022 growth and profitability targets, investors should consider that with EPS estimated in the range of EUR 7.2 to EUR 7.4, Bayer continues to trade exceptionally cheap. In fact, Bayer's FWD P/E of below x8 implies that investors may earn an equity yield of close to 13%. Such a valuation and return respectively would only be justified if Bayer would be operating in structurally challenged market. But with the agriculture demand tailwind, as well as increasing health consciousness across the world, such an assumption a declining market for Bayer - is far from rational.

Valuation Update

Accounting for Bayer's somewhat 'disappointing 2023 outlook', I update my EPS expectations for Bayer through 2025: I now estimate that Bayer's EPS in 2023 will likely fall somewhere between $2.2 and $2.4, as compared to $2.45 prior. Moreover, I also adjust my EPS expectations for 2024 and 2025, to $2.6 and $2.85, respectively.

I continue to anchor on a 3.5% terminal growth rate (one percentage point higher than estimated nominal global GDP growth), as well as on a 9% cost of equity.

Given the EPS upgrades as highlighted below, I now calculate a fair implied share price of $35.58.

Below is also the updated sensitivity table.

Risks

With regards to risk, I continue to see the Monsanto litigation as the major risk factor:

... the major headwind for the company is and will likely remain the Monsanto litigation. While the lawsuits should be manageable, and Bayer has set aside adequate funds for potential liabilities, the costs are still open-ended and uncertainty persists. However, one could argue that Monsanto is the opportunity, not the risk, as without the litigation investors would never be able to buy Bayer at such a cheap valuation. At this point I see the risk/reward skewed to the upside.

Conclusion

Bayer delivered strong FY 2022 results, beating analyst consensus estimates with regards to both topline and earnings. However, markets punished the stock lower following the earnings release, due to a perceived weak 2023 outlook. But investors should consider that EPS projections of between EUR 7.2 and EUR 7.4 imply a continuation of strong demand. And Bayer's FWD P/E of x8 would only be justified if either Bayer's market would be structurally pressured, or Bayer's competitive strength would diminish -- both assumptions are far from reasonable. That said, reflecting on strong FY 2022 results, ongoing structural tailwinds, as well as a super cheap valuation, I am confident to reiterate a bullish recommendation.

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