Bayer AG (BAYN) is a 150 years old German life science company with core competencies in health care and agriculture. It is well known for its product Aspirin. The group consists of 392 companies in 87 countries and has the following divisions:

  • Pharmaceuticals, 41% of sales in 9 months 2020 – focuses on prescription products (especially for cardiology, women’s healthcare), therapeutics in oncology, hematology and ophthalmology and the radiology business.
  • Consumer Health, 47% of sales – markets non-prescription products in the dermatology, nutritional supplement, allergy and other categories.
  • Crop science, 12% of sales – deals with seeds, crop protection and non-agricultural pest control.

Bayer has a long history of acquisitions. Perhaps the biggest (and unfortunate) one is US company Monsanto bought in 2018 for USD 66 B. Monsanto has severe ongoing litigation concerning its product the herbicide Roundup with active component glyphosate. That acquisition has led to the increase in debt and reputation problems for Bayer. The company’s S&P long term rating was lowered to BBB stable in 2018. In its third quarter report the company says that it intends to secure a separate class settlement agreement to address potential future Roundup litigation. There are around 125 K claims to be settled. It is not yet clear how much the litigation could cost but the company expects it to be around EUR 9.6 B.

   Revenue

Sales graph of Bayer shows consistent revenue growth since 2016. In the first three quarters of the challenging 2020 sales were down 4.2%, mainly due to negative currency effect.

Many parts of the company’s business are recession resistant. Pharmaceutical sales were negatively affected by the pandemic, e.g., by delays in operations in hospitals. However its revenue is down only 4% for 9 months of 2020. Revenue in Crop Science division is down also just slightly, 3.4%. The most cyclical division is Consumer Health with sales down almost 8%.

The company revised its growth expectations for 2021. The pandemic has led to the reduced longer – term growth expectations. It revised sales growth in Crop Science from 2% to 1% and in Consumer Health from 4% to 5%. Total revenue is expected to be at the 2020 level and adjusted earnings below the 2020 level. Bayer is benefiting from both aging and growing population as it leads to the increase in global healthcare spending. The trend will continue in the future. It creates strong basis for the rebound in Bayer’s revenue in the coming years.

   Profitability

In the first three quarters of 2020 the company has had net loss of EUR 10.8 B and negative earning per share (EPS) of EUR 11 per share. In agricultural business the company has taken the impairment charges of EUR 9.3 B.  It was mitigated by the sale of the Animal Health business which resulted in a cash inflow of EUR 4.28 B.

To evaluate the profitability of businesses, it is better to have a look at profits before special items. It can be seen that underlying profitability has not changed much year – on – year:

  • EBIT before special items, EUR 5.65 B, is almost the same as in 9 months 2019.
  • Adjusted (core) EPS is EUR 5.07 while for 9 months of 2019 it was EUR 5.09.

So the adjusted profits are resilient the pandemic related challenges.

To tackle worsened macroeconomic environment Bayer intends to cut operational expenses of EUR 1.5 B annually as of 2024. That could lead to job cuts in near future. In addition the company is reviewing its businesses with the aim to exit non – strategic ones. These measures together with the resilient revenue should lead to the improved profitability in the coming years.

   Dividend

Bayer used to be a reliable dividend payer as dividend payments have been stable and growing for many years. Dividend is up 4.5% on average each year since 2014. Since 2017 dividend has not been changed and is EUR 2.8 per share. The dividend yield is attractive at 5.2%. The company’s dividend policy is to pay 30% to 40% of adjusted earnings per share (EPS). Adjusted EPS for 9 months 2020 is EUR 5.09 per share. So Bayer could end 2020 with adjusted EPS around EUR 6.

Payouts in the coming years are expected to be at the lower end of the range. Low payout ratio means that a dividend would be well covered by earnings in the future. However there is a risk of dividend cut as the company should deal with high debt and litigation.

   Financial Strength

At the end of September total financial debt of Bayer was EUR 43.45 B. With EUR 31.48 B the company’s D/E ratio is as high as 138%.

Net operating cash flow for the first three quarters of 2020 is EUR 4.15 B, down 16% versus 9 months of 2019 and free cash flow is EUR 1.85 B, down almost 27% year – on – year. Net operating cash flow is only 9.5% of total debt. So debt is not well covered by operating cash flow.

The company intends to use for debt reduction part of additional operational savings.

Bayer’s high debt will put pressure on research, capital expenditure, dividend and other areas of activity.

   Investment case

Bayer’s shares recovered from the pandemic caused crisis. Then they have been under pressure in the autumn due to litigation risks and rebounded somewhat again.

Now we estimate the future share price of BP using historical average P/E ratio. The following assumptions are made to project a stock price.

  • We assume that roughly EPS in 5 years will be the same as in pre-covid 2019, EUR 4.17 per share.
  • Dividend is EUR 2.8 per annum. According to the dividend policy, it would be 30% – 40% of core EPS, which is around EUR 6. So we could assume dividend of EUR 2 that would not change in the coming years. Under this assumption over the next 5 years the total dividend income would be EUR 10 per share.
  • Future buy backs are not considered.

Multiplying EPS (EUR 4.17) by the average P/E over the last 5 years (20.28, see Stockscreen), gives us the rough indication what could be the stock price in 5 years period:

EUR 4.17 x 20.28 = EUR 84.57

That means Bayer’s stock price upside potential is 57% from the current price of EUR 53.75 if our assumptions come true.

Taking into account the expected dividend income over the next 5 years (EUR 10 per share), the overall return on investment, if the stock is bought today, with dividends not reinvested, could be around 76% over the 5 years period or about 12% compound return each year on average. That seems to be good enough reward for the exposure to Bayer’s risks.

Bayer has promising, recession – proven business model. It is well diversified across products and geographies. At the same time its current headwinds are significant. Numerous litigation cases are damaging to its image. High debt and considerable losses for the first 3 quarters of 2020 make investing in the shares of Bayer a bit risky. Also there is a risk of dividend cut and related negative impact on stock price. The coming years might be tough for Bayer but taking into account the current share price overall risk/reward combination seems to be favorable. This company managed to stay afloat for 150 years and should whether current headwinds as well.

 

Notes

Source of pictures – the company website unless otherwise stated.

Colored circles next to headings mean an author’s evaluation of the relevant performance criteria of the company: green means positive, yellow neutral and red negative evaluation.

The estimates made in the article are for the informational purposes only. They are the result of the rule of thumb assumptions and the real outcome might differ materially from those estimates. As the future unfolds, macro events, not mentioned in the article, could impact the company fundamentals. Use the information in the article as a starting point for your own due diligence.

Leave a Comment