- Fresenius management is reviewing its group structure to make sure capital markets give it more appreciation. We remain skeptical given its opaque disclosure.
- The outlook for FY12/2021 is less than robust, as we estimate flat net income and falling free cash flow generation YoY. Accounting government subsidies as revenues in FY12/2020 look odd.
- With adjusted free cash flow yield dropping to 6% from 10% YoY, we remain sellers of the shares.
Fresenius (OTCPK:FSNUF) provides opaque free cash flow disclosure and management comments that a review of the company structure is underway to get a deserving valuation. The outlook for FY12/2021 is similarly vague at net income level. With our estimated free cash flow to drop YoY we remain sellers of the shares.
We aim to investigate the following:
- To assess CEO comment about the company structure being under review, and implying that the capital markets are not giving a level of appreciation the company deserves.
- The outlook for FY12/2021.
We will take each in turn.
Previously we wrote about our concerns about company disclosure, namely a misleading cash flow statement with no distinction made between parent and large non-controlling interests. We did not think the company made enough effort to determine free cash flow that was attributable to Fresenius shareholders.
For FY12/2020 results, the pro forma versus our adjusted free cash flow figure looks as follows (taking net income attributable, and the pro rata amount based on shareholdings for operating cash flow and capex from group companies). The difference is palatable:
|Pro forma disclosure||Our attributable estimates|
|Net income (€m)||2,823||1,796|
|Current FCF yield (%)||21.0||10.0|
Source: Company, created by author
It therefore came as a bit of a surprise when management reported FY12/2020 results with a comment by CEO Stephan Sturm about the company structure being under review. Sturm felt the need to ask whether the capital market is giving them the value that they deserve. Clearly he feels something is amiss.
If management were to believe that the shares are undervalued based on current pro forma disclosure which potentially overstates group free cash flow, we would respond that this measure was incorrect to begin with.
Whilst some analysts assess the complex group structure as being a discouragement for investors, we have no problems here as long as disclosure is fully transparent.
The company has said there are no plans for immediate changes, but we imagine all sorts of proposals are landing on management's desks from bankers to 'unlock' value.
Management has left the medium-term guidance of 5%-9% net income growth unchanged. This left us slightly confused as a cost-savings program worth €100 million per year by FY12/2023 should result in higher growth. However, any changes to the group structure may be instigated if it comes clear that medium term growth forecasts are unrealistic. We may get to hear about such proposals if operations in FY12/2021 are off to a poor start.
Management gave an opaque guidance for FY12/2021 with sales to grow low-to-mid single digits YoY under constant currency, and net income said to be 'broadly stable'. A relative lack of conviction appears to come from a general understanding that the impact of the pandemic will still be felt in all business lines during H1 FY12/2021, wearing off into H2 FY12/2021.
There also appears to be the following issues to tackle in the shorter term. New production plans are on hold at Melrose Park following a Form 483. And into FY12/2021 the company stressed that it will see meaningfully less German government support in its hospital operation side - the majority of subsidies received in FY12/2020 have been booked as revenue. The accounting here sounds a little strange. For example under Dutch GAAP COVID-19 wage cost subsidies are under other operating income or deducting actual labor costs. This follows the principal of IAS20.
The longer term concern we have is for the biosimilar business where management still have projections of high triple digit sales by FY12/2024. Whilst we would not discount this possibility in its entirety, there needs be a fairly massive ramp-up in activity quickly if this was to be executed.
On flat net income YoY for FY12/2021, the shares are trading on PER 10.9x. With capex we estimate it will remain at similar levels YoY, but working capital may become weaker YoY as the business aims to recover activity into H2 FY12/2021. With cash flow from operations set to fall YoY, free cash flow should follow a similar route - we concur with consensus free cash flow of €2,552 million pro forma (a decline of 39% YoY) - and on an adjusted basis €1,200 million (a decline of 40% YoY). The resultant adjusted cash flow yield is 6.0%.
A potential positive is a change to the group structure that would make Fresenius Medical Care (FMS) a 100% consolidated subsidiary. This would be a costly affair but would address the issue of having large non-controllable interests.
We believe the outlook for Fresenius should improve into H2 FY12/2021, but issues remain over disclosure and what we view as limited potential earnings from the sub-scale group companies Kabi, Helios and Vamed. Management commenting on deserved valuations for its business is not a positive indicator. With free cash flows set to fall YoY, we remain sellers of the shares.
This article was written by
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