2023-07-20 17:05:44 ET
Summary
- Danish bioscience company Chr. Hansen, which specializes in the commercial production of enzymes, has impressive gross margins of over 54% and net margins of over 17%.
- Despite weak market trends, the company has reported near-double-digit organic revenue growth, solid EBIT margins, and over 500M DKK in free cash flow, driven by growth across all segments and a favorable taxing structure.
- The proposed merger of Chr. Hansen with Novozymes is expected to create a larger industry giant, with the combined company focusing on microbial and fermentation.
Dear readers/followers,
Investing in some of the older companies in Europe is rarely a bad idea if you can get said company at a good valuation. Chr. Hansen ( CHYHY ) is a company I've written about a few times in the past, but the last article was actually several years back, in 2019.
Chr. Hansen is a global bioscience company with a history spanning over a century. It's Danish - the number of Danish investments I hold is actually very limited overall. Its primary field of business is the commercial production of enzymes, a crucial part of any part of a diary culture, meat/wine, or protection - but the company also has exposure to things like natural coloring, and health and nutrition.
Such areas are, if executed correctly, obviously attractive investments. I mean to give you an update here on this investment - a small one - and why I've been adding slowly and mean to add more over time.
Chr. Hansen - A giant in enzymes and bioscience
So, as I mentioned - Chr. Hansen focuses on parts of the food value chain that are crucial to our overall industry.
You should, if you follow my work, be familiar with my overall reasoning for owning and wanting to own a stock like this - outperformance and profitability. Chr. Hansen gives us these upsides. With a gross margin of over 54% for bioscience industrial, and an operating margin of above 26%, this is a very profitable operation. The bottom line for Chr. Hansen showcases net margins of over 17%, making it a market that outperformed in the 90th percentile on all margin levels, from gross to net (Source: GuruFocus). The company's income statement breakdown shows us a COGS of less than 45%, which for this sort of company is amazing, and an OpEx of 28.8% - above the 25% I usually expect, but it's important to remember that the company has a very expansive R&D department - SG&A is at about 21%, which is good.
Net margins for 2022 were at 18.5%
As I said - extremely impressive. The market is, as I see it, woefully underestimating Chr. Hansen and disregarding a low debt, excellent 21x+ interest coverage ratios, and an ROIC profitability net of WACC that hasn't been even close to negative since GFC, even with today's interest environment. The company has no excessive dilution, SBC, and has an impressive Stockholder Equity at over 50% of total assets.
In terms of the sales mix, it's around a 63/37 mix of Cultures/Enzymes and Nutrition respectively, and geographically, 36 and 30% go to EMEA and the US, with the remaining split between APAC and Latin America and other segments.
Chances are if you eat it, they do it . Food cultures, enzymes, food coloring, and bioscience focused on improving yields, human safety, and fighting off pests/diseases - that's sort of where the company is currently, and where the focus lies - and that is obviously attractive. Its operations also include ambitions to reduce sugars, increase food safety, and work towards a more "natural ingredient" mix on a forward basis.
Part of the reason why the company has seen relatively sub-par performance is, I believe, that the exposure to China has been relatively substantial, and for the past 10 years, it's also been increased by the company. The reasoning from Chr. Hansen was similar as with many other companies expanding to emerging/new markets, in that legacy growth was low, and China was an underpenetrated market here.
The company is not a high dividend yielder. During lows, it can come in below 1%, which in the context of the current interest rate environment is unacceptable to me unless there is significant, outsized growth to be had beyond that dividend. During the best of times, the company's yield can rise to around 2.5%, which is A-okay to me, given what some stalwarts on the US market yield. It's also worth noting that Denmark, with very few exceptions, isn't a market where you'll find a lot of higher-yielding companies. You'll find more in markets like Finland, Sweden, and Norway.
The last set of company results we have are the 3Q22/23, which were released about 1.5 weeks ago. Despite what we can see as weak market trends, Chr. Hansen is actually performing well. Near-double-digit organic Rev growth, very solid EBIT margins, and over 500M DKK in FCF.
These improvements were driven by growth across the group's segments, and a split of both volumes and price/mix, though most increases are driven by price as the company works to offset inflation and other pressures.
On a geographical basis, there was a continued decline in APAC - which we've seen for some time - but growth in LATAM especially, with decent growth in EMEA and NA as well.
The strong sales also improved profitability beyond the impacts of higher input costs and a less favorable product mix. Positive trends here are pricing and scalability, which have really brought home some of these improvements beyond unfavorable FX as well.
The company's higher working capital is in turn more than offset by profit and a more favorable taxing structure, driving FCF up and driving the company's outlook for the 2023 fiscal, at an 8-11% organic revenue growth, a solid 25%+ EBIT margin, and FCF above €200M. Russian sanctions and geopolitical macro naturally remain a sensitivity and something to definitely keep a look at.
Let's also not forget the big news item - the proposed merger of Novozymes with Chr. Hansen, to create an even bigger giant in the industry. This process is massive, and it's currently in the regulatory stages to seek approval - however, the company has already restated financial highlights based on calendar quarters, and full closing is expected in the fourth quarter of the calendar or first quarter of 2024. This also includes the agreement that Hansen shareholders will receive their proposed dividend for the fiscal earnings for 2023E, ending in August.
But at a high level, Chr. Hansen is a high-margin, impressive bioscience company with operations in several key areas. The addition of Novozymes will add to this appeal, and bring to the table scaling advantages that will turn this company into an even more attractive investment in the field. Both of the companies have exposure to what I would consider underlying global megatrends, with a focus on microbial and fermentation-based tech, and a strong mind for sustainable products. They do this in a way that generates very good margins and strong free cash flow. The low dividend is a "price" I'm willing to pay in this context in order to get what the company offers.
This also brings me to what I would focus on when I look at this company. I want to make sure that this company's extremely attractive margins are maintained despite geopolitical uncertainty, increased costs, and inflation. And in fact, it seems like margins, as you can see above, are being maintained. Once Novozymes is merged into this business - and I don't foresee any regulatory hurdles when it comes to this, I'll do an update on the merged company and its future capacities (there may be an article before that as well), but for now, I'll focus on Chr. Hansen's capabilities and its potential future, as we move forward towards the end of the year, which for this company is in August.
Let's look at the company valuation.
Chr. Hansen Valuation - There's a significant upside to be had here
So, how much should we want to pay for a microbial and fermentation tech leader? This is a huge market, and the company is a leader here. Overall, we're looking at an impressively growth-oriented company in an extremely defensive sector which, inarguably is contextually relevant in our modern society and touches every area of basic human nutrition available.
You have to realize when investing in Chr. Hansen that there is an absolutely significant premium you need to accept. The company rarely trades below 30x P/E for any extended period of time - usually, that's when you want to "BUY" the company, and I managed to pick up a few shares during that time back in last fall when it last dropped to those levels.
Going forward though, this is a company that you need to forecast at 35-38x p/E in order to see any amount of solid RoR. I'm willing to do this given the combination of fundamental safety, very solid business area, good historicals, and high analyst accuracy with over 80% analyst accuracy of either hitting or the company beating estimates.
Forecasting the company at that higher end 37x P/E, we get a potential annualized RoR of 15.6%, with a total upside of nearly 40% in 3 years. That's "good enough" for me given what the company does. It's far from a huge position for me, but it's a defensive diversification sort of investment.
S&P Global analyst averages for the company begin at 600 DKK/Share and go all the way up to 850 DKK/share - but the conviction from these analysts despite a PT of 710 DKK/share on average is low, with only 2 out of 10 analysts at a "BUY" rating here. I interpret this as those wanting to wait for the merger with Novozymes and see where the "new" company goes after this - which is understandable. However, I would argue that there is enough upside even at this point to consider adding small portions of shares to your portfolio here.
The main question is if I am changing my 2019-established "BUY" rating given what is essentially a very poor RoR. That is not something I am willing to do here, because I have a high conviction that the company is stable, and will continue to perform well. Even better, I believe it will deliver very solid returns with the addition of Novozymes to the mix, which will further increase the appeal here.
Here is my thesis for Chr. Hansen holding - and it's a positive one, despite the overall high valuation.
Thesis
- Chr. Hansen Holding is a leader in technologies relating to microbial and fermentation, specifically enzymes, and Health/Nutrition. The company has averaged double-digit earnings growth for over 10 years and is usually traded at a high premium akin to some of the highest P/E companies out there.
- In order to invest in the business, you need to accept that high premium and that potential high growth rate outlook, as well as the meager yield of below 2%, currently at 1.39%.
- Because I accept the premium and forecast the company at above a 30x P/E, I can see a double-digit upside here if the company continues to manage double digit growth and give the business a PT of around 620 DKK/share.
- That makes this company a "BUY" here, and one of the highest P/Es of any company that I accept.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
I will not call the company "cheap" here, but I will say that it has an upside - and for that reason, I give it a "BUY".
For further details see:
Chr. Hansen: Not A Great Performance, But Looking Forward