Celesio: An Undervalued Drug Wholesaler That Could Double in Price

| About: Celesio AG (CAKFY)

Celesio AG (OTCPK:CAKFY)(OTCPK:CAKFF) is a German pharmaceutical and healthcare company that is one of Germany's oldest stocks. Celesio was founded by Franz Ludwig Gehe in 1835 and started trading on the Dresden stock exchange in 1904, more than a hundred years ago.

From its humble beginnings as a drugs, paints and chemicals retailing operation, the company has grown in to one of Europe's largest pharmaceuticals distribution and retailing companies. It is the largest listed company of its kind in Europe, after Alliance Boots was taken private by KKR in 2007. Its other main rival in Europe is Phoenix Pharmahandel, a privately held company which is Germany's largest drug wholesaler and the second largest in Europe.

Celesio's business

Celesio operates all along the pharmaceutical value chain. One part of the operation is the wholesale distribution of drugs to pharmacies (manufacturer solutions and pharmacy solutions), where the company operates in 12 countries. This is essentially a highly specialized logistics, warehousing and wholesale operation that ensures pharmacies have the right supplies on time - a kind of toll bridge between drug manufacturers and pharmacies. The pharmacy retailing division (patient and consumer solutions) directly operates some 2,000 pharmacies in seven countries, but not in its home market. A special law in Germany prohibits the operation of pharmacy chains – pharmacists can only operate up to four pharmacies. Celesio had high hopes that the EU would force Germany to repeal this law, and bought the Dutch mail-order pharmacy DocMorris in 2007 for nearly 200 million EUR to penetrate the German market. However, the law has been upheld by the European courts in 2009. Today, DocMorris operates pharmacies in Germany under a franchise system.

Celesio's geographical revenues mainly come from France (29.4%), the U.K. (20.9%), and Germany (18.7%). The acquisition of Brazilian pharmaceutical distributor Panpharma has yielded 1.5bn EUR in revenue last year, which makes Brazil Celesio's fourth-largest market, with 6.5% of revenues. Further contributions come from Austria, Norway and other countries.

Current issues

After being a stock market darling for the best part of the last decade, Celesio's share price has taken a severe beating over the last three years (see chart below). After reaching highs above 50 EUR per share in 2007, the share price is currently well below 20 EUR – levels that were last seen in the years 2000 and 2003. While Celesio AG is mainly traded on its home market in Germany, there is an active listing for its unsponsored ADRs in the US under the symbol (CAKFY.PK). The ordinary shares can also be traded under (CAKFF.PK), but are less active. The ADRs of Celesio represent one-fifth of an ordinary share. The current price is in my view quite attractive, as some issues around the company have created a very depressed share price, while the operating figures have not changed much. Compared to its historic valuation, and to other listed competitors, Celesio is currently undervalued.

share price history
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The main issue around the company is not an operational one, but related to its main shareholder, the Haniel group. Haniel owns about 55% of Celesio's stock, and relations with the main shareholder have been strained for some time. Haniel has large debts and is unwilling to finance any expansion plans of the company. Already in 2009, Haniel tried to prevent the value-creating acquisition of Panpharma in Brazil. The tensions culminated recently with CEO Fritz Oesterle, who headed the company for the last 12 years, leaving the company. Haniel had discussions with a Chinese company to sell its Celesio stake, but the talks went nowhere. The Haniel boss, which is also the chairman of Celesio, recently gave an interview to the FAZ newspaper, criticising the company. The comments have drawn sharp critisicm from Celesio's executives, who sent an angry letter to their board and the Haniel group.

In my view, the main reasons creating the current negative sentiment around the company are

  • Celesio's dependence on regulated markets
  • The company's inability to make larger acquisitions because it lacks support from the main shareholder
  • The main shareholder's intentions to withdraw from the company, creating a perceived share overhang
  • Strained relations with the main shareholder and the search for a new CEO

Historically undervalued

To get the best possible historical analysis, I went back on 18 years of financial statements which are summarized in the table below. The table contains Celesio's main figures regarding revenue, net income, and balance sheet data. The last rows give the market's historical valuation of Celesio at the year-end, by giving the year-end price-to-earnings, price-to-book and price-to-revenues ratios and dividend yield based on the respective year's financials and the year-end market capitalization.

financial review
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The numbers show that Celesio currently trades far below its historical valuation. Consider the following figure, which gives the historical ratios for each year, and the long-term average:

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Celesio's current P/E ratio is around 11, while the 16-year average (excluding the years 2008 and 2009, where the P/E was negative) was 18.6. In the 1990s, Celesio stock even regularly traded at P/E ratios above 25. The company's price-to-revenues ratio currently stands at about 0.12. The 18-year historical average is double that amount, 0.24. Celesio's revenues have grown fivefold over the period, and the operating margin has been stable around 2% on average. The price-to-book ratio is also less than half of its historic average. Celesio currently trades at about 1.1 times book value, while the 18-year average is 2.4. Its current dividend yield of nearly 3% is also much higher than it was in the past.

All in all, the stock price could double if Celesio gets back to its historical average metrics.

Undervalued relative to listed peers

Celesio's largest competitors in Europe, Alliance Boots and Phoenix, are not public companies. There are however some international companies that operate in the same market. I have compared the current valuation metrics of seven international competitors to those of Celesio in the table below.

In the USA, CVS Caremark (NYSE:CVS), Walgreen (WAG) and Pharmerica (NYSE:PMC) operate in similar markets. CVS and WAG are about ten times larger than Celesio in terms of market capitalization, while Pharmerica is about ten times smaller. Generally, the US companies have higher equity ratios (above 50%) than Celesio (31%). CVS and PMC have lower returns on equity, while Walgreen has the highest return on equity. The valuations of US peers are more expensive, with P/E ratios from 14 (CVS) to 21 (PMC), and price-to revenues of 0.22 (PMC) to 0.57 (WAG).

peer comparison
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In Japan, Suzuken (OTC:SZUKF) and Sundrug (OTCPK:SDGCF) are similar companies that have about half of Celesio's size each. They command higher multiples (P/E ratios of 13-14), along with German competitors Sanacorp and ANZAG (Andreae-Noris Zahn).

Celesio currently has the lowest price-to-earnings ratio among the group, and the third-largest return on equity (10%).

Return on equity

The return on equity has nearly always been that good at Celesio. The 18-year average ROE is about 13%, with the highest figure being 22.2% in 2001. Excluding dividends, which have been on average 4.3% of equity, the compounded annual growth rate of Celesio's equity was 9.3% over the last 17 years. If the historical trend remains intact (see figure below), the current pricing at slightly above book value offers the opportunity to capture about 12% long-term annual equity returns.

equity returns
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The market currently offers Celesio stock at a bargain price. Historical valuation metrics, the comparison with listed peers and the current valuation in itself all point to a strongly undervalued security. While there remain operating and strategic issues, I believe the current stock price of around 16 Euros is too cheap. Buying at these levels should provide satisfactory long-term returns for the patient investor.

for more information about the company, the reader is referred to the company website, especially its annual report and recent investor presentation.

Disclosure: I am long Celesio AG.