FUJIFILM Holdings: Beginning To Deliver On Healthcare Diversification

Summary

• We have assessed FUJIFILM's transition to date as a healthcare business. The conclusion is that they have made material progress, and the outlook is positive.
• The secular decline in office equipment business needs to be managed, but healthcare should continue to scale via M&A and capex to generate growth overall.
• With the shares trading on PER FY3/2022 15.9x and a free cash flow yield of 5.9%, we are buyers of the shares.

Investment thesis

FUJIFILM (OTCPK:FUJIY) is positioned for improving profitability and sustained free cash flow generation, as it continues to scale its operations in healthcare. The shares do look cheap on PER FY3/2022 15.9x and a free cash flow yield of 5.9%.

Quick primer

Established in 1934, FUJIFILM is a fine chemical manufacturer spun out of Daicel (OTCPK:DACHF) producing photographic film. It has been expanding into healthcare, focusing on expansion as a contract development and manufacturing organization.

Our objective

We would like to assess how FUJIFILM's expansion strategy into healthcare has delivered in terms of:

• Acting as a successful exit plan from legacy imaging and document businesses.
• Whether it has been successful in raising overall returns for the business.

We will take each one in turn.

Exit from legacy

FUJIFILM has not been idle in the face of digitization. As the core imaging business compromising of photographic film and paper was down-scaled, the company embarked on diversifying into healthcare and life science businesses. A major strategic move was the acquisition of biopharmaceutical business Merck BioManufacturing Network in 2011, a leading contract development and manufacturing organization (CDMO) for biologics, viral vaccines and vectors.

Sales split FY3/2020

Source: Company, created by author

As the healthcare segment of the business grew, the profitability of the business began to recover.

Operating margin trend

Source: Company, created by author

That being said, the return on equity (ROE) has also improved but remains quite low. This is partly as a result of an over-capitalized balance sheet, which has enabled smooth M&A activity.

ROE trend

Source: Company, created by author

The company has effectively run down its Imaging business, but the Document Solutions despite digitization headwinds continues to act as a cash cow. The failed acquisition attempt Xerox (XRX) in 2018 has ultimately led to the termination of its sales global partnership from March 2021 and will increase competition particularly in growth markets in Asia. However, this latest move looks less onerous given FUJIFILM's push into healthcare and its involvement in CDMO, and the pandemic-driven trend of work-from-home and lowering need for office equipment.

The healthcare business has continued to grow at pace. In March 2019 the company acquired Biogen's (BIIB) manufacturing company in Denmark and the diagnostic imaging business from Hitachi (OTCPK:HTHIY) which is due to be completed in 2021. The pandemic has also acted as a tailwind, with healthcare earnings growth accelerating in Q3 FY3/2021. The CDMO business is seeing better sales mix and is currently involved in the manufacturing of Novavax's (NVAX) COVID-19 vaccine which is currently in phase 3 clinical trials in the US. This vaccine has the advantage of being able to be stored and shipped at normal refrigeration temperatures. Medical systems are also seeing improving demand for X-ray equipment used to diagnose pneumonia and for endoscopes.

From this we conclude that although overall profitability and ROE may not be very high to date, FUJIFILM has successfully diversified into healthcare. We now look at the prospects going forwards.

Expecting steady growth in healthcare

There are two key drivers in FUJIFILM's expansion in healthcare. Firstly, the acquisition of Hitachi's medical imaging business will increase FUJIFILM's global share to around 9% from 3%, bringing it closer to its rival Canon (CAJ). Although this is a market dominated by GE (GE), Siemens Healthineers (OTCPK:SEMHF) and Philips (PHG), it gives more scale to the company's activities and should boost margins in the division.

The second is associated with the CDMO business, where the company has announced in January 2021 that it will invest $2 billion to establish a new large-scale cell culture manufacturing site for biopharmaceuticals in the US. Expected to be operational in 2025, this expansion will allow the company to triple current capacity from 132,000 liters to 418,500 liters of bioreactor tank capacity - this will make FUJIFILM the second largest biopharmaceutical CDMO in the world after Samsung Biologics (207940 KS).

With a decline in operating profits in FY3/2021 as office equipment sales fell away, consensus is estimating a recovery in operating profits into FY3/2022, and continued margin expansion into FY3/2023 primarily driven by healthcare.

Consensus operating profit and margin forecasts

Source: Refinitiv, created by author

From this we conclude that the outlook for FUJIFILM's earnings is positive, driven by the healthcare business combined with an ex-growth but steady performance in Document office equipment.

Valuation

Despite continued need for investment into the healthcare business, consensus outlook for free cash flow generation is relatively stable. The prospective free cash flow yield for FY3/2022 is 5.6% despite an expected YoY decline.

Free cash flow consensus forecasts

Source: Refinitiv, created by author

The shares are trading on consensus PER FY3/2022 15.9x, and with a dividend yield of 1.7%. The PER multiple is low for what appears to be a business transforming into a higher return healthcare business.

Risks

The Document office equipment business looks relatively exposed after the pandemic. With printer demand on the decline in tandem with office space, FUJIFILM has execution risks over recovering sufficient sales volumes into FY3/2022 and beyond.

Longer term risk in the CDMO business would be a lack of contract wins to manufacture biopharmaceuticals from drug makers, despite the large committed capex base.

Conclusion

FUJIFILM has dealt with the structural challenges it faced with digitization better than most of its peers. Performance metrics have not been particularly exciting in terms of profitability which may account for the relatively low valuations the shares trade at. However, free cash flow generation has been consistent and looks sustainable going forwards, and the shares do look cheap on PER FY3/2022 15.9x and a free cash flow yield of 5.9%. We are buyers of the shares.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.