BIOGY - Staying The Course: BioGaia's Growth Amid Uncertainty

2023-07-26 11:32:21 ET

Summary

• BioGaia's probiotics have received top ratings and the company has seen rapid growth, but concerns are raised about the company's ability to maintain this amidst leadership changes.
• The company achieved a 41% revenue increase in 2022, surpassing SEK 1 billion in sales, with significant growth in the APAC region and the Americas, and a 55% increase in operating profit in Q1.
• Despite promising long-term growth prospects, uncertainty in leadership and potential market issues may impact short-term performance; investors should be cautious in the short term and buy for the long term.

Introduction

BioGaia ( BIOGY ) has accomplished product excellence with top ratings online for its spectrum of probiotics curing everything from child colic to bloatedness. Beneath this success, however, lies a lingering concern – can the company maintain its rapid growth, especially amidst the imminent shift in leadership? And could uncertainty in leadership offset some of the product excellence in growth and if so, is BioGaia still worthy of investment considering today’s valuation?

Historical background

In the late 1980s, Peter Rothschild discovered the power of probiotics when he witnessed the transformative benefits of incorporating Limosilactobacillus reuteri to preserve organic vegetables imported to Sweden. Acquiring the rights to these probiotics sparked the initial plan of utilizing them as a supplement for feedstock, replacing antibiotics. Although multiple successful clinical trials demonstrated their efficacy, the adoption of a costlier drug limited its anticipated growth.

In 1996, Rothschild took the helm as CEO, shifting from being an active board member and investor. Over the next two decades, he orchestrated a remarkable turnaround by targeting health-conscious individuals. Today, the company boasts over 200 clinical studies substantiating the positive health effects of lactobacillus, with substantial investment in researching diverse probiotic strains to expand its product portfolio ( BioGaia Sales ).

Turning away from history

In the spring of 2016, Rothschild handed over the role of CEO to Axel Sjöblad, but his tenure was short-lived, as he left his position for SenzaGen about two years later. In 2018, Isabelle Ducellier took over as the current CEO and President. However, just like her predecessor, she announced on 29 March of this year that she had decided to leave BioGaia. She will instead join Orkla as CEO of the Orkla Health portfolio company by the end of September 2023. Now, the question arises whether there are some organizational and systematic problems within BioGaia that could potentially impact its high growth rate seen in the past. This is especially important to consider given the challenges posed by the current tougher market climate. Also, the current insider ownership is pointing towards a risk of goal incongruencies as the management could have a lesser incentive to outperform in my opinion, owning relatively few shares in the company ( Leadership ).

The 1.8% inside ownership is mainly contributed to Rothschild who owns a total of 3,703,340 A-shares and 500,000 B-shares. The total registered share capital of BioGaia AB consists of 3,703,340 class A shares and 97,278,970 class B shares, meaning that he owns all the A-shares and about 0.51% of the class B shares or about 38 times more shares than the current CEO Isabelle Ducellier (who owns 13,065 shares). Now, even though this may be an inherent risk, there is still a lot of potential and historical expansion, a positive note that we will look at next.

The stats

Lactic acid bacteria is now utilized in numerous BioGaia products and these are currently available to purchase in over 100 countries. The company achieved remarkable success, with a 41% revenue increase in 2022, surpassing SEK 1 billion in sales. Though the pace of growth has slightly slowed down this year, it remains impressive, particularly in APAC and the Americas. In the APAC region, sales surged due to the reopening of China following the second wave of Covid, and significant contributions came from South Korea, the Philippines, Malaysia, and Thailand. In the Americas, the growth was driven primarily by BioGaia Canada, a new subsidiary established after ending the agreement with their former distributor Ferring. The positive effects of synergies are now evident with BioGaia USA and online channels, where sales via Amazon (AMZN) have played a significant role. (Annual report 2022)

Not only are the sales figures impressive, the operating margin stands at 40%, resulting in an operating profit of SEK148M in the first quarter. This represents a remarkable 55% increase compared to the corresponding period last year. The management is determined to safeguard these figures, including its high gross margin of 72%. In an interview with the Swedish newspaper SvD, Rothschild emphasizes that maintaining these margins is crucial to support their strategy of allocating 13% of revenue to R&D spending, ensuring they remain at the forefront of product innovation. Nonetheless, these figures have somewhat decreased in the second quarter - so is this growth trend going to continue?

There are concerns about cooler market conditions and leadership uncertainty impacting revenue growth, potentially worsening in the near future with the appointment of a new CEO this fall. The figure below displays varying growth figures, and sustaining extreme growth seems challenging. Nonetheless, the Adult Health section and the Americas region demonstrate sustained demand for BioGaia's offerings, while APAC may rebound further with the easing of COVID-19 concerns and an improved economic outlook in China.

Growth projection

I have made a 2030 projection based on 2018-2022 historical compounded annual returns in sales and averages in earnings before interest and tax ("EBIT") and net income. I have created a range of compounded revenue growth through 9-16%, which is in line with its historical 10.45% growth. Furthermore, I assume that the company's "EBIT"/Sales ratio stays constant over time. This means that the company could achieve projected sales of between 2.8 billion SEK and 18.2 billion SEK and a projected net income of between .770 billion SEK and 4.9 billion SEK. Although these ranges are broad, they provide a frame for where BioGaia could be in 7 years. If we assume that the neutral case is fulfilled then the company would be valued at around 48 billion SEK (1.7 billion net income x 27.4 "P/E") compared to its current valuation of 9.9 billion SEK. Hence, the company has a considerable hefty upside potential of 4.85x if it can expand compounded sales growth to 12.5% and uphold its incredible operating margins.

Competitive landscape

There are several players in the probiotics market; Chr. Hansen Holding A/S, Custom Probiotics Inc., Dietary Pro Labs, Koninklijke DSM N.V., NutraScience Labs (Twinlab Consolidated Holdings Inc.), Probi USA Inc. (Symrise AG), ProbioFerm, Protexin (Archer-Daniels-Midland Company), Reckitt Benckiser Group plc and Vitakem Nutraceuticals Inc, is just a sample. However, this is to some extent an untapped market that will become ever more important in the fight against the growing number of diseases (diabetes, cancer, cardiovascular diseases, etc.) as research shows that the use of probiotics can play an important role in cancer prevention. If Globe Newswire’s growth estimation for the market for probiotics is close to true; “The global Probiotics Market was valued at around USD 62.4 billion in 2022 and is estimated to be worth approximately USD 131 billion in 2032, growing at a CAGR of 7.9% between 2023 and 2032”, then there is room for growth for BioGaia despite potential competition. Also, something to have in mind is the uniqueness of each company’s offerings as a result of their patents, which allows, for instance, BioGaia to pursue a differentiation strategy targeting the premium segment and hopefully maintaining margins.

Conclusion

In conclusion, BioGaia shows promising potential for long-term growth, driven by high expected sales in APAC and the Americas, a thriving probiotics market, patented products, and continuous innovation. However, the uncertainty in leadership and potential market turbulences warrant caution in the short term and a buy in the long term. I believe that long-term investors will capitalize on BioGaia's growth prospects. As the company's strategic initiatives unfold, a clearer picture of its resilience and growth trajectory will emerge.

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