Risk-Reward Is Balanced at Bayer

| About: Bayer A.G. (BAYRY)
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We are maintaining our Neutral recommendation on Germany’s Bayer (OTCPK:BAYRY) with a target price of $86.00.

With its headquarters in Leverkusen, Bayer is one of the world’s largest healthcare and chemical corporations. Bayer operates in three major segments - Healthcare, Material Science and Crop Science. The HealthCare segment is involved in the research, development, manufacturing and marketing of products for the prevention, diagnosis and treatment of diseases.

The Material Science segment is one of the world’s largest polymer manufacturers. The Crop Science segment is one of the world's leading crop-science players in the areas of crop protection, non agricultural pest-control, seeds and plant biotechnology. The three segments contributed 48.4%, 28.9% and 19.5%, respectively, to total revenue of €35,088 million in 2010.

In April 2011, the company presented its first quarter 2011 results. Bayer’s earnings per share during the first quarter of 2011 came in at €1.45 (approx $1.99) compared with €1.13 (approx. $1.64) in the year-ago period. Strong revenues across all segments boosted earnings. (Read our full coverage on this earnings report: Strong Quarter at Bayer, View Upped)

All sectors at Bayer are expected to continue performing well driving growth at Bayer. However, we believe that investor focus will be on the fate of blood-thinner Xarelto, co-developed by Bayer with Johnson & Johnson (NYSE:JNJ), for preventing stroke and systemic embolism in patients suffering from non-valvular atrial fibrillation (AF) going forward more than earnings reports. The candidate, which has block-buster potential, has been filed in the US, the European Union and Japan for the indication. If the blood-thinner is approved then the top line at Bayer will significantly expand.

However, we remain concerned about the generic threats/competition faced by Bayer on many of its products such as Levitra (erectile dysfunction) and the Yaz franchise (oral contraceptives). The genericization of key drugs would negatively impact revenues at Bayer.

The Yaz franchise is already facing significant generic competition with sales declining 18.3% in the first quarter of 2011. We expect Yaz sales to continue declining. Moreover, any hiccups or delays in the approval of Xarelto will weigh heavily on the stock. Consequently, we see limited upside potential from current levels and retain our Neutral view on the stock.