Fresenius: An 8-20% Undervalued German Giant
Summary
- Fresenius is a massive $35B market cap company out of Germany in the healthcare sector. It's one of few German companies with an alternative listed on the NYSE.
- This makes investing in the company or segments far simpler than with ADRs and makes the company more potentially appealing for international investors.
- I recently increased my stake in this company.
- In this article, I show you why I consider Fresenius a "BUY" here.
Fresenius (OTCPK:FSNUF) (OTCPK:FSNUY) is a large German healthcare company out of Bad Homburg in Hesse. In this article, I want to share this company's foundations and positioning with you, and show you why I consider this company one of the few investable businesses out of Germany.
After abandoning my automotive companies due to excessive cyclicality and volatility and lack of transparency in terms of forwarding returns, I'm extremely selective about my German investments.
However, Fresenius checks all of the boxes.
Let me show you how.
Fresenius - What does the company do?
The company was founded in 1912 by Eduard Fresenius. The company's present focus began back in 1966 when the company began with dialysis. Today, the company's focus and services are centered around dialysis services for hospitals and inpatient/outpatient medical care.
The company is also involved in hospital management and engineering services for healthcare facilities.
The company is a market leader with a global presence in over 100 countries, €36.3B worth of sales in FY20, and over 310,000 employees across the world. In many of its areas, Fresenius holds a #1 market position, allowing the company a decent moat for its products and services.
In previous articles, we've been through that the healthcare sector thanks to population growth, is set to expand significantly. While the companies active in it will likely see margin compressions and cost control, it doesn't change the fact that the market-leading companies will likely enjoy years and decades of profitable growth, if they play their cards right.
The fundamentals are on Fresenius' side.
(Source: Fresenius Investor Presentation)
Fresenius has 4 interesting and excellent operating segments.
(Source: Fresenius Investor Presentation)
- Fresenius Medical Care is a publicly traded company in its own right, of which Fresenius owns a third. The company/segment focuses on Chronic Kidney failure and is headquartered in the US, and if you invest in the NYSE Ticker FMS, you're investing in the medical care AG, not the overarching company described here. Fresenius Medical Care is a superb company, and it has 38% of the dialysis market in the entire USA. It's a great investment in its own right, but I'm looking to own the overarching company, not just FMS.
- Fresenius Kabi AG supplies the market with essential drugs, nutrition, and medical devices. It's primarily a biosimilar/generic producer that focuses on oncology products, including Paclitaxel, Irinotecan, Oxaliplatin, Gemcitabine, Cytarabine, Carboplatin, Topotecan, Docetaxel, and Epirubicin.
- Fresenius Helios is the largest hospital operator and provider of inpatient/outpatient care in Germany. The Helios clinics have more than 110 hospitals and 30,000 beds, treating 5% of the entire German population each year at 4 million annual patients.
- Fresenius Vamed develops and manages healthcare facilities, including post-acute care facilities and other types of healthcare locations.
The company's sales are internationally diversified but are currently focused mainly on two geographies.
(Source: Fresenius Investor Presentation)
Europe and NA together make up 85% of sales, and despite 6% CAGR growth in sales the past 4 years, EBIT for the past year has actually dropped somewhat, indicating some challenges in the company's operations to deliver earnings from higher sales.
The segments have performed excellently in terms of overall sales growth for the past years, with the exception of FY20 for Vamed, which saw significant negative pandemic headwinds.
(Source: Fresenius Investor Presentation)
The company's medical care arm alone has almost as much sales revenue as the other 3 segments put together. The Helios operation is second-largest at around €10B in annual sales revenues to the Medical care business €18B. Vamed is still very small at barely €2B but is growing.
On a segment-by-segment basis, the company's Medical Care wing is probably the most appealing and wide-moat of the operations. The company provides world-leading dialysis services and provides services to ~350,000 patients every year at around 4,000 clinics. The company saw 3% patient growth in 2020, and 37% growth in home treatment in the US.
I like Fresenius Kabi, as the company with its generic drugs and biosimilars have a strong market position, helping cost-conscious healthcare providers save money in both the US and the EU, and Fresenius expects a 6.3% CAGR growth from the segment until 2030. The focus for the segment is on organic growth as opposed to inorganic, and further focus on developing biosimilars with oncology and autoimmune focus.
Fresenius Helios might be unknown and far away to our US readers, but the segment's fundamentals are extremely convincing to me.
(Source: Fresenius Investor Presentation)
It's the sort of hospital operator that I in my mind want to own, with the prospective growth found in Spain and LATAM, already a private hospital market operator with a 12% market share. The potential for expansion here as the company starts to accelerate the segment is, to my mind, underestimated.
Vamed remains the small brother of the quartet. It manages Hospital construction and expansions thanks to years-long expertise, with a strong track record of over 900 projects in 90 countries, operating actively in 5 European countries. One of the interesting areas here is the segment's focus on emerging markets, where I see great potential for growth, albeit at higher risk, for the company.
If there's one thing where this company shines, it's the dividend. Fresenius is a US-rated dividend aristocrat with 28 years of consecutive, recession-resistant dividend increases, coming to CAGR 15% since the financial crisis of 2008.
(Source: Fresenius Investor Presentation)
Despite this increase, the company's payout ratio has remained typically German - stable and rigid, at around 23-27%. The company's ownership structure and shareholder structure is German to 48%, with only 18% US ownership. However, for the past years, the company's valuation and share price have been an absolute downer.
(Source: Fresenius Investor Presentation)
We'll get more into that in company valuation.
So, this is what the company does, and where they do it. The company's current operations are focused on a few things - namely what most companies are currently involved in in the form of streamlining and making things more efficient. The entire company seems to be under the microscope to deliver savings and efficiencies going into 2021.
(Source: Fresenius Investor Presentation)
If delivered, these could improve the margins of the company by not inconsiderable amounts. Kabi is set to deliver perhaps the most significant expected near-term growth due to its biosimilars, including Adalimumab introduced in 2019, and a whole host of generic/biosimilar drugs set for release until 2025E.
Sales projections in this segment are set to skyrocket over the next few years.
(Source: Fresenius Investor Presentation)
The company's FY20 results were impressive enough for the environment they operate in. A 2% net income growth in the last 2020 quarter was decent results, and the company managed to deliver according to 2020 targets. The mid-term expectations are for the company's cost measures to start delivering, and the company expects for the earnings growth to start to materialize.
On a segment-specific basis, the company's expectations are as follows.
(Source: Fresenius Investor Presentation)
This is based on an expected receding of COVID, with burdens beginning to lighten. The company expects 2H21 results to be significantly improved, especially in elective procedures, due to increased vaccination coverages worldwide.
(Source: Fresenius Investor Presentation)
The COVID-19 impacts for the company are far from over at this point - but they're expected to decline to go into the second half of the year. The company's respective segments are bound to improve eventually, and I believe that the situation will look very different once we hit July-August of 2021.
Another thing to look at is the company's debt ratio. Fresenius has a strong history of inorganic growth through acquisitions, the debt of which is then paid down following the purchases. Unfortunately, Fresenius entered COVID-19 with a higher-than-normal net debt/EBITDA ratio. While the company's credit ratings are solid at BBB investment-grade and the company's maturities are fairly well-laddered...
(Source: Fresenius Investor Presentation)
Given the company's structure, it's important to bear in mind that FMS is only 30% owned by Fresenius, and this impacts both valuation and how we should view things such as this. The company remains at a health >40% equity ratio, and the company has kept this is in a very narrow range, targeting 40-45% despite the recent growth of the company.
So, to conclude a bit.
Fresenius is a conservatively run, German healthcare giant, active in areas of Dialysis, generic/biosimilar drugs, hospital management and hospital construction/project management. The company is a dividend aristocrat with conservative safeties, and while recent results since 2016 have impacted the share price negatively, earnings have stayed strong.
The company is in the midst of making things more efficient, and coming out of the pandemic, the company's expectation, and the market expectation is that Fresenius will improve their results and valuation multiples could expand.
Let's look at where that puts the company's valuation
Fresenius - What is the valuation?
So, remember.
One valuation is present is for Fresenius Medical Care (NYSE:FMS). That's the dialysis business, which is primarily found in the US and lacks some of the international appeals, but also international exposure of Fresenius SE Co & KGaA, which is the entire company, found in Germany.
The other valuation is for the German ticker FRE and the ADRs for Fresenius SE, which is your way of investing in the entire company.
Let's begin with FMS.
(Source: F.A.S.T. Graphs)
FMS trades at around 12.9X average weighted P/E and expects an EPS shortfall due to COVID-19-related morbidity in its dialysis business. Nonetheless, following this, results are expected to expand significantly. Until 2020, the company has delivered fairly impressive overall sales numbers and earnings numbers; however, the stock has suffered significant declines and no longer trades at a premium.
Given the company's fundamentals and market position, I only believe it to be a timing question when this development reverses. While Fresenius doesn't have a spotless accuracy record in terms of forecast, the potential discount you're getting here is significant, and the estimated earnings growth is well above the market average at nearly 8-9%, with double digits every year following 2021.
(Source: F.A.S.T. Graphs)
Even assuming a conservative 15X P/E fair value, you're potentially getting 65% until 2024 at 14% per year, which is excellent, should it materialize. Any return to a premium, which I don't view as unlikely given the company's market position of close to 40% would bump these results up to nearly 100% total RoR until 2024 at a P/E of 18X with annual growth rates of almost 20%.
The company's yield is sub-par and below the current 10-year at 1.44%. However, I'd like to remind you that the company is a grower, not a shower, and will grow this dividend going forward.
For the past 20 years, FMS has delivered average dividend growth rates of 10.1% and has delivered returns nearly on par with the S&P 500 despite the poor performance for the past 3-4 years. If you had focused on buying the stock at an undervaluation above that of today in terms of P/E back in 2009, your returns would have been over 104% even with the drop we've seen. If you had seen the company's overvaluation back in 2017 and rotated out some profits - which I likely would have done, the returns would have been 214%.
(Source: F.A.S.T. Graphs)
Successful investing for me is based on buying cheap and, if necessary, selling at expensive levels to maximize returns and to rotate the proceeds into undervalued companies. This company could have enabled such a strategy in the past, and will likely enable it in the future.
Analysts share the view on the company's share price targets.
(Source: Author's Calculations, S&P Global, Google Sheets)
The undervaluation seems clear to me not only from historicals but from current trends. The lowering of overall price targets is derived from the expected, and factual COVID-19 impacts on the dialysis business. However, none of these impacts are likely to be long term, but will probably ease once vaccinations come into full force. I, therefore, consider FMS to be worth a 15X P/E on a 3-year forward average EPS, which puts it at around $39/share, or an undervaluation of 9%. If we exclude the expected 2021 impact year and focus on forward potential, this goes up to 46.25, or an undervaluation of over 26%.
This makes Fresenius Medical Care a "BUY" to me.
As to Fresenius SE, found under ticker FRE in Germany, or ADRs FSNUF/FSNUY, these are how things look here.
Fresenius trades at around an 11.24X to normalized Earnings, which is even better than the FMS ticker in terms of valuation and undervaluation.
(Source: TIKR.com)
The company also trades at a discount to its cash flow multiple average, at around the current 3.59X of NTM price/CF per share, with the 6-year average being closer to 8X. It's clear that the company's recent problems have impacted the company's valuation from several perspectives.
The company produced GAAP EPS of €3.06 for 2020 and is expected to grow this by 3.7% in 2021, followed by nearly 20% GAAP EPS growth in 2022, which more or less mirrors the positive expectations for FMS. If this growth materializes and the company's valuation in terms of P/E follows suit, then we're likely to see similar levels of returns for both the ADR and the German-listed common share.
In fact, expectations for the ADR are set to outperform the FMS ticker on a 15X P/E multiple targets on a 4-year basis...
(Source: F.A.S.T. Graphs)
... and in terms of every metric, even for the ADR which is an ORDX4 ADR, the company trades at a severe discount to its operating cash flow multiple. This is what cash-flow-based undervaluation looks like.
(Source: F.A.S.T. Graphs)
The target for the company's Germany-listed shares FRE is as follows.
(Source: Author's Calculations, S&P Global, Google Sheets)
Assuming a 15X forward P/E based on average estimates, the company's price target comes to around €45/share, which grants us a current upside of nearly 20%. The upside for the main ticker is therefore somewhat higher than the FMS ticker. This doesn't make Fresenius medical a bad investment, but at a 2021 2.45% yield, it has a better yield and a better upside in my view.
My price target for the Germany-listed FRE ticker is €45/share, which should then be adjusted including FX to represent the target for the ADR's. Either option is undervalued in my book.
FRE, FMS, FSNUF, FSNUY are all "BUYs" in my book.
How to invest in Fresenius
So what's the takeaway here? I'm going to take a detour from my normal options/common share-based investment logic and say the following.
I believe that any long-term investor who has the ability to do so should seriously look at the German-based FRE ticker. Even considering the dividend tax, the potential return from investing in the company at this valuation for the next 4 years could be 100% of invested capital.
That is also the thesis and the investment I am going to go with here. I own FRE, and as of a few days ago, I started adding more.
However, I realize that for some of you, investing in a German ticker may not be possible. You then have the ADRs as a possibility. This may be a go for some, but others may say that they don't want to invest in ADRs as a rule, which I respect. I'm unsure whether I would do it if left in a US investor position.
However, in that case, you have 8-20% undervalued ticker FMS, which are the company's dialysis operations, with impressive US moats and market share. The 4-year potential upsides here are also between 60-100% in case of a reversal of the company's trends, which is of course a market outperformance of some degree.
I, therefore, believe Fresenius's available common shares and investment possibilities have something for everyone that seeks to invest in this German giant.
Let me know your thoughts here, and if you have questions.
Wrapping up
Fresenius is a company that's been around for a long time. I said that the company had roots to 1912 - which is true. However, the very real roots go back nearly 550 years, to the "Hirsch" pharmacy, which was taken over by Fresenius in the mid-1800s.
While company age itself doesn't lend a business any more investment security, I always find it important to prioritize history over companies that are literally founded only a few years or months back. Historical trends are important to me.
Fresenius has proven over the years that it has the ability to navigate the modern market. Their 4 business segments are profitable, and the plans for each of them seem realistic from my view. The market positions for the hospital operations and dialysis are well-entrenched in their geographies. Their biosimilars are expected to grow massively, and even their construction arm has a well-filled order book for 2021.
In short, it's a superb company that I consider likely to outperform the market over the next few years. It's a company I want to own, and in my recent shift towards even more quality above yield, it's a perfect candidate for my portfolio.
What are your thoughts on Fresenius? Let me know in the comments, or send me a message. I do my best to answer everyone within 48 hours.
Thank you for reading.
This article was written by
Wolf Report is a senior analyst and private portfolio manager with over 10 years generating value ideas in European and North American markets.
He is a contributing author for the investing group iREIT on Alpha where in addition to the U.S. market, he covers the markets of Scandinavia, Germany, France, UK, Italy, Spain, Portugal and Eastern Europe in search of reasonably valued stock ideas. Learn more.Analyst’s Disclosure: I am/we are long FSNUF. 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.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
Option Disclosure: NO Puts/Calls written
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (16)
If you think price will go up then buying calls makes more sense to get better leverage if someone is comfortable.
