SDMHF - Sartorius: Expect More Bad News

2023-06-20 05:46:45 ET

Summary

• Sartorius AG's stock price fell over 15% after the company lowered its forecast significantly.
• Sartorius may also fail to achieve its 2025 revenue targets, despite reaffirming its guidance in that regard.
• The €2.4 billion acquisition of Polyplus weakens the company's balance sheet and may lead to a capital raise.

Sartorius AG ( SARTF ; SUVPF ) recently lowered its forecast materially. The company issued a statement Friday evening. The German market was closed over the weekend, but today (Monday, June 19th) the stock price fell more than 15 percent.

Sartorius as an equipment supplier to the biopharmaceutical sector is a typical pick and shovel play, thus pretty much agnostic to the success of individual drugs. The company sells a range of materials and devices for bioprocessing (including bioreactors, fermenters, various cell culture media) as well as high tech lab supplies. A relatively high share (about 75 percent of the bioprocessing segment and 50 percent of the lab product and services segment) of revenues is recurring. It is overwhelmingly likely that the biotech and biopharmaceutical market will see significant future growth . Predictions for the coming years range from CAGR of about 7.3 to 8.2 percent. Sartorius itself assumes around 10 percent (2021 to 2026), which appears to be rather towards the higher end (if not slightly above) consensus estimates. To be fair, there are also some forecasts of 12.5 percent and above. Nonetheless, I would argue that the company has been rather optimistic, which in turn translates to somewhat greater downside potential.

So, while I am not denying, that there may very well be a splendid future ahead for the company in the long run, I believe that in the short to medium term there may be significant headwinds. Below, I will explain why I do not believe Sartorius to be a good investment at the moment.

Negative Growth and Balance Sheet Deterioration

Sartorius now forecasts a revenue decrease in the mid-teens (previously: single digit growth) and an EBITDA margin deterioration to 30 percent (previously: in line with 2022 = 33.8 percent). Net debt to EBITDA is now forecast at a 2.2 times multiple (previously: 1.5), excluding a €2.4 billion loan to finance the acquisition of Polyplus through listed subsidiary Sartorius Stedim Biotech S.A. ( SDMHF ) in which the parent holds a 74 percent stake. That translates to 2023 EBITDA decreasing by 20 to 25 percent YoY.

While that in and of itself is bad news, it also weakens the company’s balance sheet. Most of the group’s debt is concentrated at the level of the parent company. Sartorius reported net debt of €4.25 billion as of March 31 ^st . This figure does not include the acquisition of Polyplus which will be financed with a €2.4 billion bridge loan made to Sartorius by JPMorgan ( JPM ). That results in a Net Debt/EBITDA multiple of about 5.8 times. A weaker balance sheet in an environment of rising rates, may also lead to a higher interest burden going forward. On debt of €2.4 billion the annual interest expense could easily be in the range of €120 million, which would be around 10 percent of Sartorius’ 2023 EBITDA.

To make matters worse, Sartorius is paying a rather high price for the acquisition. According to the seller, Archimed Group, the company generated annual revenue of €75 million. That is a revenue multiple of around 32. That is far above what Sartorius paid for prior acquisitions such as Albumedix Ltd and Xell AG which were acquired at sales multiples in the low teens. These were much smaller ticket items, too.

For 2023, Sartorius expects upper double digit million euro sales and a “substantial” EBITDA margin. Forward EBITDA hence will probably be somewhere between €20 million and €35, translating to a multiple between 68 and 120, which is by no means cheap either. After the transaction, there will likely be massive additional goodwill on the books (in addition to €1.7 billion already on the books as of March 31 ^st ).

Sartorius plans to refinance the bridge loan. In an environment of relatively high (and rising) interest rates, that will almost certainly cost more on a relative basis than the company paid for prior acquisitions. The company might issue new equity in order to refinance. Notably, the company explicitly states that those “long-term financing instruments […] might include an equity component”. A capital raise of up to €1.2 billion (= an equity component of 50 percent) would result in significant dilution of around 5 percent based on the current share price. A lower stock price in the medium term would, of course, translate to even higher dilution. With €3.55 to €3.75 annual revenue in 2023 and an EBITDA margin of around 30 percent, 2023 EBITDA of around €1.1 billion can be expected. That means the stock is currently trading at close to 20 times 2023 EBITDA. That already is not overly cheap, as is.

Medium-Term Targets Doubtful

Furthermore, I believe that further bad news is not unlikely. Sartorius confirmed its 2025 guidance. But I believe it is far from certain that it reaches its target. Notably, this would require annual growth rates of 15 to 20 percent (based on the assumption of FY2023 revenues of €3.55 billion to €3.75 billion), which is above Sartorius’ historical averages. I expect the coming 18 months to probably be a time in which companies with high cash burn – which applies to many biotech players, especially smaller ones - will try to rein in spending as much as possible given the increasingly growing cost of capital. Under these circumstances, above average growth rates are even more ambitious. Especially, if at the same time higher margins are targeted. Therefore, I would not at all rule out further profit warnings going forward.

Consolidation Is A One-Way Street For The Foreseeable Future

Another downside is that Sartorius can partake in industry consolidation only as an acquirer, not as an acquisition target until at least mid 2028. Due to stipulations in the will of late former CEO Horst Sartorius, his heirs may not sell their stake representing 50.9 percent of voting rights until then. Notably, Lothar Kappich, chairman of Sartorius’ supervisory board , is Horst Sartorius’ Testamentsvollstrecker (a position roughly comparable to a common law executor, though there are material differences). Hence, there is no possibility of being acquired at a premium anytime soon. At the same time, the company may need to continue buying smaller competitors in order to preserve market share, which could further increase the debt load.

Conclusion

In the long run, demographic developments, namely increasingly older populations in developed nations, will surely drive demand for medicinal products, including biopharmaceuticals. And Sartorius will probably take its share of the cake.

In the short term, I view it as a sell. I doubt that the company will be able to achieve its 2025 targets. Further profit warnings could send the stock price tanking again. Relatively low trading volumes may exacerbate that effect further. Furthermore, I expect either the issuance of new equity or significant interest expenses as a consequence of the Polyplus acquisition.

While the company has a good track record of consistent dividend growth, the absolute dividend yield of well below 1 percent (at the current share price, it is in fact closer to half a percent) does not really make it an attractive proposition for its dividend alone. The preferred shares’ yield is even lower at a mere 0.47 percent.

In the short to medium term, I believe the stock could fall to around €200 per share (about $218 at current exchange rates), the level it traded at before the Covid-induced windfall years. The preferred shares usually trade at a premium of around 10 to 20 percent, so, seeing no real reason why this should change, I would see them at around €220 to €240.

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