NVZMY - Novozymes: Growth Up Margins Down
2023-07-17 08:45:23 ET
Summary
- Novozymes is increasing prices to counter soft demand and high costs, but end markets probably won't tolerate rising prices indefinitely.
- With generally weak input price inflation, Novozymes' stock price is likely to be determined by the interplay of rising margins and softening growth in the near term.
- Longer term, Novozymes needs to generate more growth to justify its current valuation.
Novozymes ( OTCPK:NVZMF ) continues to push through higher prices to offset soft demand and elevated costs. While cost pressures are likely to ease going forward leading to higher margins, pricing could also become a growth headwind. Novozymes' valuation has returned to a more reasonable level, but current prices still aren't a clear buying opportunity. Novozymes still needs to demonstrate traction in growth markets and the proposed merger with Chr. Hansen is a source of uncertainty.
Market
Novozymes’ enzyme expertise provides exposure to a range of end markets, many of which are relatively mature and offer limited growth. There are also a number of growth opportunities that the company could capitalize on in coming years. The future of some of these markets is not currently clear though for economic or technical reasons.
Detergents
Enzymes provide a number of benefits when used in detergents:
- Lower the use of surfactants
- Reduce the need for perfume
- Help detergents to maintain performance at a lower pH
- Replace polymer functions like fabric care and whiteness
The use of enzymes in detergents in developed markets is relatively mature though, and as a result growth is limited. In comparison, enzymes are underpenetrated in emerging markets, which could be a significant growth driver for Novozymes. While this is a large opportunity, adoption is currently being held back by costs and consumer acceptance / awareness.
Table 1: Use of Detergent and Enzyme Penetration in Emerging Markets Relative to Developed Markets (source: Created by author using data from Novozymes)
Plant-Based Meat and Dairy
Plant-based meat and dairy are potentially large markets, although there are still questions around how widely these products will be adopted by consumers, particularly if these products cannot reach price parity with meat and dairy.
Novozymes products can help with:
- Scale-up and commercialization of fermentation
- Protein functionalization
- Pathway discovery
- Protein extraction and purification
Figure 1: Global Plant-Based Retail Market Size (source: Novozymes)
Survey data indicates that taste and texture are currently the primary barrier to adoption. Novozymes provides enzymes that can improve the properties of plant-based meat and dairy, which may help to grow the market. This is currently an investment area for Novozymes, with the company making a significant investment in a manufacturing facility in the US.
Figure 2: Barriers to Adoption of Plant-Based Meat and Dairy Alternatives (source: Novozymes)
Food price inflation has probably been a headwind for this segment over the past few years, with consumers opting to trade down. Costco recently suggested that consumers were switching from beef to chicken, a common trend during recessionary periods. Similar dynamics may be at play within plant-based meat and dairy, something that is supported by the struggles of companies like Beyond Meat ( BYND ) and Oatly ( OTLY ).
Biofuels
Biofuels are a relatively important market for Novozymes, particularly in the US, but this market has offered little growth for over a decade. Despite this, Novozymes has been able to create some growth through product innovation. Novozymes also believes that markets outside the US will be supportive of growth for its bioenergy business.
Figure 3: Global Ethanol Production (source: Created by author using data from The Department of Energy)
Table 2: Regional Starch-Based Ethanol Production Estimates 2019 (source: Created by author using data from Novozymes)
Sustainable diesel production is also a growth area which Novozymes' bioenergy business has exposure to.
Figure 4: Sustainable Diesel Production (source: Novozymes)
Figure 5: US Biodiesel Production (source: Created by author using data from the Department of Energy)
Agriculture
Ag biologicals are another large opportunity for Novozymes. In particular, biological alternatives could replace a portion of the 100 billion USD nitrogen fertilizer market. Novozymes’ solution fixates 25-30% of the required nitrogen , allowing the replacement of 50-60 lbs of fertilizer per corn-acre per year.
Figure 6: Agriculture Opportunity (source: Novozymes)
Carbon Capture
Novozymes has been working with Saipem to implement a low-cost enzymatic post-combustion carbon capture solution. At the moment only 40 million tonnes of carbon is captured annually, significantly short of the 5.6 billion tonnes that would need to be captured in 2050 to achieve net zero emissions. Post-combustion amine carbon capture is currently the most common method. Post-combustion processes could be readily scaled as they can be retrofitted on existing industrial plants.
Enzymatic post-combustion carbon capture has already been successfully implemented at Resolute’s softwood kraft pulp mill in Canada, with a capacity of 30 tonnes of CO2 per day.
Figure 7: Enzymatic Carbon Capture (source: Novozymes)
Recycling
Enzymes and microbes can also be used to improve plastic recyclability. This could include enzymatic modification of natural polymers, enzymatic recycling and enhanced degradation of disposed plastics. 53 million tons of PET bottles and fibers are currently sent to incineration or landfill.
Figure 8: PET Enzymatic Recycling Opportunity (source: Novozymes)
Addressable Market
Novozymes' expertise in enzymes and biotechnology give it access to a large market opportunity and a number of potential growth areas. Despite this, growth has been difficult to come by outside of the surge in pricing over the past few years.
Figure 9: Novozymes Market Opportunity (source: Novozymes)
Novozymes
2022 was a year of rapid growth for Novozymes, offset by declining margins. This was primarily the result of the inflationary environment, and 2023 is likely to see a reversal of this to some extent, meaning weak growth and rising margins. The macro environment continues to be a risk, with growing signs of consumer weakness.
Figure 10: Novozymes Performance by Segment (source: Novozymes)
Household Care
Novozymes manufactures enzymes for use in:
- Laundry
- Automatic dishwash
- Hand dishwash
- Professional cleaning
Household Care revenue grew 2% YoY in the first quarter, despite volume softness in developed markets. Novozymes is currently driving growth in this segment through pricing, which is an unsustainable tactic and may need to be reversed if consumer weakness becomes apparent.
Figure 11: Household Care Performance (source: Novozymes)
Food, Beverages and Human Health
Novozymes manufactures enzymes for use in:
- Baking
- Food and protein
- Beverages
- Human health
Within Food, Beverages and Human Health, lower volumes were partially offset by higher prices . Food was relatively strong while Human Health was soft, primarily due to supply chain issues and weak demand in North America.
Figure 12: Food, Beverages & Human Health Performance (source: Novozymes)
Bioenergy
Novozymes manufactures enzymes for use in:
- Conventional biofuels
- Biomass conversion
- Biodiesel
Novozymes bioenergy business continues to grow, despite ethanol production in the US declining by an estimated 2% . Growth was aided by capacity expansion of corn-based ethanol in Latin America, biodiesel and the sale of enzymes for use in biomass conversion. Pricing was also an important contributor to growth.
Figure 13: Bioenergy Performance (source: Novozymes)
Grain and Tech Processing
Novozymes manufactures enzymes for use in:
- Grain milling and starch processing
- Distilling
- Vegetable oil processing
- Textile and leather
Higher grain prices and solid demand contributed to strong performance within Novozymes’ grain business. Pricing also contributed to growth.
Figure 14: Grain and Tech Processing Performance (source: Novozymes)
Agriculture, Animal Health and Nutrition
Novozymes manufactures enzymes for use in:
- BioAgriculture
- Animal health
- Animal Nutrition
Performance in this segment was driven by strong growth in Animal Health & Nutrition, including a benefit from the timing of orders . Agriculture was more muted impacted by a volatile end market and some destocking effects.
Figure 15: Agriculture, Animal Health and Nutrition Performance (source: Novozymes)
Chr. Hansen Merger
Shareholder approval of the merger with Chr. Hansen was received on March 30 th 2023 . Novozymes is continuing to work on gaining regulatory approval, with the deal currently expected to close in late 2023 or early 2024.
Novozymes expects costs synergies from the merger of approximately 80-90 million EUR. In addition, there could be revenue synergies of up to 80-90 million EUR. This will be offset by 250 million EUR integration costs through 2026.
While this merger could create value, there is still uncertainty regarding if and when it will occur. There is also a significant risk that expected synergies are not realized.
Figure 16: Merger Synergies (source: Novozymes)
Financial Analysis
Organic revenue growth was 5% in the first quarter of 2023. Bioenergy and Agriculture, Animal Health & Nutrition were areas of strength. With supply chain pressures in energy and agriculture easing, growth is likely to soften in these segments going forward. Food, Beverages & Human Health declined, due in part to a difficult comparable period in 2022. Consumer spending weakness may cause these segments to continue to perform poorly in 2023. Growth is largely coming from higher prices with volumes generally quite weak.
Figure 17: First Quarter Growth by Segment (source: Novozymes)
Novozymes is expecting 4-7% organic sales growth in 2023, with growth across all segments. Pricing is expected to account for more than half of this growth though, calling into question the sustainability of this growth. With supply chain pressures generally easing, inflation is rapidly becoming disinflation and in time possibly deflation, which could result in serious growth headwinds over the next 1-2 years.
Figure 18: Novozymes Revenue and Inflation (source: Created by author using data from Novozymes and The Federal Reserve)
Longer-term, Novozymes’ plans on doubling sales by 2020, indicating single-digit growth going forward. This is a modest growth target, but it is in line with the company's growth over the past decade. Given the fairly soft growth in Novozymes' end markets, it is difficult to see the company outperforming this by much. Newer initiatives like carbon capture and PET recycling are still being established and could be supportive of growth in the mid to long term though.
Gross margins declined in the first quarter as a result of higher raw material prices and transportation costs. Novozymes' price increases are beginning to yield results though, with margins up sequentially, and this could be aided by easing input pricing pressures through the year.
Figure 19: Novozymes Revenue Growth and Gross Profit Margins (source: Created by author using data from Novozymes)
Valuation
While Novozymes is a solid company, investors should recognize that the business has matured significantly over the past decade and that management have already pulled a number of one-time value levers. Margins have been fairly flat in recent years and growth modest. Leverage has also increased as Novozymes has taken on debt and repurchased stock. The company still has a number of large growth opportunities ahead of it, but there is a risk of overpaying for the stock if investors extrapolate past success.
Figure 20: Novozymes Historical Performance (source: Novozymes)
Novozymes’ valuation has declined significantly over the past 1-2 years, but I am not convinced that the current share price represents an attractive entry point. There is a risk that multiple compression offsets modest growth going forward, resulting in weak returns for shareholders.
Growth expectations for the company over the next 5-10 years are quite modest, making an extended period of weak returns a distinct possibility. This is something that investors have already faced over the past 8 years, with the stock price fairly stagnant in that time. Based on current growth expectations, Novozymes' PE ratio 5 years forward is still approximately 20. The dividend yield is also only approximately 1.7%, which is hardly attractive in the current interest rate environment.
Table 3: Analyst Growth Projections (source: Created by author using data from Novozymes)
Conclusion
Novozymes' is a solid company but outside of price inflation, it has struggled to create growth in recent years, and this is likely to continue going forward. Margins should improve with input price inflation easing, but this is also likely to weigh on growth. Longer term, Novozymes has upside exposure to areas like plant-based meat and dairy, carbon capture and PET recycling, but there is still technical and economic uncertainty associated with these. Given Novozymes weak growth prospects, the company's valuation is still fairly rich.
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Novozymes: Growth Up, Margins Down