LZAGF - Lonza: Our Thoughts Pre Capital Market Day Buy Confirmed

2023-06-30 03:41:20 ET

Summary

• Despite a challenging economic environment, Lonza announced an increase in CAPEX, positioning itself to capture long-term growth opportunities in the healthcare sector.
• We positively favor Lonza's capital allocation priorities. In addition, the company announced a new buyback program of up to CHF 2 billion.
• Despite higher competition from Asian peers, Lonza is an attractive investment thanks to new biological cures for Alzheimer's disease and RNA opportunities.

After a difficult 2022, a good stock price recovery was seen in 2023's first months. Inflation, commodity prices, and supply chain pressures are globally easing. Although it is still too early to sing victory, given the fact that core inflation remains persistently high , the picture looks rosier compared to a few months ago. Secondly, the economic outlook has improved. The fall in European gas prices , combined with the surprising resilience of households and businesses, has led the European Central Bank to revise its 2023 estimates upwards and cancel its recession forecasts. Inflation supported revenues and helped offset inflationary cost pressures, resulting in resilient margin performance. Looking ahead, while remaining cautious, there were a few firms that accelerated their investments, seeing this current challenging environment as an opportunity to consolidate their leadership. One of these players is Lonza Group AG ( OTCPK: LZAGY ) which announced a further increase in capital expenditure for 2023 as it is ramping up production capacity. Taking a longer perspective, here at the Lab, we believe Lonza is well-positioned to capture long-term growth opportunities over the next few years. The next decade will see the EU population getting older with the consequent increase in demand for healthcare products, positioning Lonza in a sweet spot. Thanks to Capital Market Day (CMD), scheduled for October 17th , we believe the company is a buying opportunity. The company is also down by 12% since a peak in early June, and this could ultimately be a favorable entry point before the CMD.

Capital Allocation Priority

Since our last update called: " Lower Expectations For 2023 ", the company reported the Q1 financial figures and also announced a new buyback program . Looking back, it was an excellent move to forecast higher operating costs and lower Lonza margins for the current year. Very briefly, after Q1, the company confirmed its 2023 guidance, maintaining an EBITDA margin estimate in the 30%/31% range and confirming a high single-digit sales growth (Fig 1). Here at the Lab, we also like the new share repurchase program. Starting in April, the company is advancing with a buyback of up to CHF 2 billion (Fig 2). Lonza's capital allocation priorities are well-balanced, so we positively view this announcement. As a reminder, the company's priorities are: 1) maintain a strong balance sheet with an investment grade commitment, 2) growth acceleration thanks to organic CAPEX, 3) higher DPS evolution, 4) bolt-on acquisitions and then 5) share buyback program to return excess capital.

Fig 1

Fig 2

H1 and CMD projection

For the H1 results, here at the Lab, we are forecasting revenue growth of 7% at CHF 3.1 billion. Our internal forecast includes a 40 basis points headwind from lower COVID-19 sales and a minus 2% sales from unfavorable currency evolution. Our core EBITDA margin is forecasted at 28.5%, leading to a core EBITDA forecast of CHF 883 million. We also believe that management will reiterate the 2023 guidance. Including an ongoing FX headwind, the outlook reiteration would imply 8% revenue growth for H2 and at least a 31.5% core EBITDA margin. On Capital Market Day, we believe Lonza will provide three-year targets for 2024-2027. Lonza's new industrial capacity is coming online, so we believe the company will accelerate its revenue growth trajectory, and we are forecasting a CAGR in the mid-teens growth. We expect the company's guidance to be maintained at '33-35%' at the EBITDA margin level.

Conclusion, Valuation, and Risk

The significant cut in Sartorius's 2023 guidance had negative implications for the whole sector. Despite that, Lonza has strong product demand, so any read-across from Sartorius' warning is expected to be limited. However, we would like to emphasize Samsung Biologics' recent development. In October 2022, they started a new industrial plant, the world's single largest bio-manufacturing facility, and here at the Lab, we believe it will continue to gain market share. We believe that Asian peers are aggressively targeting biologics drugs, and the recent Pfizer deal goes in this direction . To compensate for this negative evolution, we should also say that Lonza will benefit from the new biologics treatments such as new RNA opportunities and Alzheimer's new biological cure.

The company remains a good pick in the EU Life Science. There is MACRO support from an aging population, and MICRO support thanks to an ongoing buyback that should sustain Lonza's stock price development. We continue to see Lonza as an attractive investment due to its long-term revenue growth trajectory and best-in-class EBITDA margin. Last time, we already reduced Lonza's target price from CHF 650 to CHF 620 per share, and today, we confirmed our view, valuing the company with an EV/EBITDA multiple of 21. Additional risks include 1) investment reduction in biological drugs, 2) customer pricing pressure, 3) capacity under-utilization, and 4) regulatory inspection failures.

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