Bayer AG is a global enterprise which operates mainly in healthcare, agriculture and high-tech polymer materials. However, the company announced plans to spin off its materials business and focus solely on healthcare and agriculture. Considering the latest global healthcare developments and Bayer’s strong position in this market, such a strategic shift could create better growth opportunities.
Market outlook: Global healthcare market is booming, agriculture is slowing down and polymer materials experienced a revival
Bayer’s healthcare segment benefits from a strong market environment. Global demand for healthcare and pharmaceutical products is increasing, because growing populations and consumer wealth accelerate the need for advanced treatment and better medical products.
On the contrary, the agricultural market weakened in 2015, mostly due to lower commodity prices for products like cereals or milk. Moreover, government regulations and rising environmental awareness in Europe make it more difficult for companies like Bayer to sell their products.
Polymer materials are used in different industries like automobile, aircraft, packing materials, pipes or insulation. Therefore, Bayer’s Material Science division is subject to a variety of industry trends. Recently, most of these industries have been been doing well which had a positive affect on Bayer’s business.
Additionally, the Germany-based Bayer AG benefits from a weaker Euro. According to their quarterly statement, currency effects had a positive effect of 5% on the company’s earnings per share.
Bayer announced to spin off its polymer materials business and is preparing for a strategic shift
Bayer announced to focus on healthcare and agricultural products in the future. Therefore, the management plans to spin off its Material Science division and sell it to the public as an independent company. The new company will be called Covestro and the IPO is expected to take place in 2016. Analysts estimate the valuation of Covestro at between €8 billion and €11 billion.
Covestro could become the fourth-biggest supplier of polymer materials in Europe behind BASF, LyondellBasell and Evonik. Last year, the division reported sales of €11.6 billion. Considering these numbers, Covestro will be a candidate for Germany’s major stock index Dax.
Bayer will outsource risks and will continue to grow its healthcare business organically as well as inorganically
Dealing with polymer materials is a much more unstable business than healthcare or agriculture. During the Great Depression, sales of the Material Science division decreased by 30%, says Bayer’s CEO Marijn Dekkers. Spinning off the division is a way to outsource these risks.
Moreover, Bayer needs cash to grow its healthcare business with further acquisitions. In the end of 2014, Bayer completed the acquisition of Merck & Co’s consumer care business for $14.2 billion, which made Bayer the leading over-the-counter drugs manufacturer in North and Latin America.
The spin-off will also be important to improve Bayer’s debt position. The latest acquisition will boost net debt from €8.5 billion to almost €20 billion. Additionally, Bayer faces more than €11 billion in provisions for pensions.
Revenue and profit have been increasing, especially in the healthcare division
All three major divisions performed well in Q2 2015 and the reported revenue was €12.1 billion. That means total revenue was up 18.2% year over year. Healthcare accounted for almost half of Bayer’s total revenue (48.9%) in Q2, followed by Material Science (26.3%) and Crop Science (22.5%).
Bayer could increase its core earnings by 33.8% year over year to €1.98 per share. Net income came in at €1.15 billion, 20% higher than in Q2 2014.
Especially Bayer’s healthcare division was performing well. Compared to Q2 2014, the division’s revenue was up 28%. Major drivers were recently launched products like Eylea, Xarelto, Adempas and Stivarga.
Eylea has become one of Bayer’s most successful products and will be a significant value driver in the future
The eye disease therapy Eylea is one of Bayer’s main sales drivers in 2015. The product had a difficult start, because Germany’s watchdogs judged that it doesn’t provide any additional benefit compared to other products. However, Bayer discovered new indications for the product which makes it a major competitor to similar eye disease therapies sold by Novartis and Roche.
Eylea is on its way to become a blockbuster drug in 2015 and contributed significantly to Bayer’s increase in healthcare sales. Bayer cooperates with the US pharmaceutical company Regeneron on the global development of Eylea. Outside the US, Bayer markets the product and both companies share development costs and profits. However, within the US, Regeneron owns all rights to Eylea and gets all profits.
Bayer pays a dividend yield of 2%, which is about average for a Dax company
Bayer paid a dividend of €2.25 at the end of the fiscal year 2014. That amounts to a dividend yield of 2%, which is also the average of all Dax companies. Historically, Bayer’s dividend has almost steadily increased, especially during the last five years. The latest increase was in line with analysts’ expectations.
The P/E ratio is 19x, which seems a bit high. However, considering that the average P/E ratio over the last ten years was about 22x, there is still growth potential.
Moreover, the company has a quite high debt to total assets ratio of 73%. That is also a result of the recent acquisition of Merck’s consumer care business. However, considering that the average equity ratio of German Dax companies is just about 29%, that’s not a red flag.
Conclusion: Bayer undergoes a strategic change which will prepare the company for the future. It’s a solid investment for short-term and long-term investors
Bayer’s Q2 report came in quite strong, so the company developed well over the last months. All three divisions performed well and earnings per share increased to €1.98. A 2% dividend yield is not bad, but also not too exciting.
Besides solid financials, Bayer has a strong product pipeline. The cooperation with Regeneron turned out to be fruitful and Eylea is on its way to become a blockbuster drug in 2015.
Moreover, Bayer will sell its MaterialScience division, which will provide cash for further M&A activity in the healthcare market. Bayer will strengthen its position and get ready for the future. The stock is a buy at 19x P/E ratio and a 2% dividend yield.