Bayer AG an undervalued company or still high risk

 Is Bayer AG an undervalued company or still high risk due to RoundUp! court cases?

Will shortly review Bayer from my perspective and apply similar principles as with my Alibaba review, first financials, dividends and then the political or in Bayer's case the damage lawsuits impact on shareholder value. One important question be answered, is Bayer AG undervalued excluding RoundUp! and what is the case when we add RoundUp!? This will be mainly a summary of historical number and not speculation around Bayer's future profits.

Let's jump straight into the numbers.

 

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Bayer AG Financials

Starting with Bayer's income statement since 2004 we see good revenue growth, stable gross margin while operating and net profit swings a bit. The biggest swings are due to one-off items, yet the goodwill write down made 2020 had a huge negative impact. Here we clearly see the importance of due diligence in big mergers and acquisitions as the Goodwill can eat up most of a company's equity in a very short period.

Income Statement

Revenue and gross profit including the gross margin in percentage has been very good and what we should expect from a pharma company. Even after Monsanto acquisition gross margin in percentage has stayed on the better side of 50 %. Since 2004 Bayer AGs revenue has grown by 2,35% per year which is a bit modest comparing to smaller companies, however for a big company like Bayer it is a proper result. 

The positive part is the gross margin and that we see a small growth in revenue. Even if there was years with almost no growth or declining revenue it still is normal for every company and I do not worry that much about it.

Next up is Operating profit, an operating margin %. As the graph displays the margin and profit has been growing with the business from 2004 until 2018 when Monsanto acquisition was finalized. Operating margin in % dropped from a healthy 16% to under 10% (around 9,6-9,9%) which clearly reflects the negative impact from Monsanto. Only in 2004, 2009 and 2010 did Bayer have a operating margin in % below 10%, if this is the new standard then one question I ask is, what shareholder value was created with Monsanto acquisition?

Net profit is what many look at and also EPS (earnings per share), as this is the result the company makes and could distribute to owners in many forms. Bayer AGs net profit has been developing well since 2004, a few highs in 2007, 2016 and 2017 mainly driven by non-reoccurring payments. In 2020 we see a big drop caused by goodwill write-down of around 2,2 billion euros and significant legal risk of 13 billion euros all related to the Monsanto acquisition (available in Bayer AGs 2020 annual report notes on page 189, other operating expenses). Without these two items we would have seen a good result from the company, however the legal claims and goodwill value of Monsanto is still a big question. We will see the impact on Bayer's balance sheet of the legal claim and goodwill write-down.

 

 Bayer's pay-out ratio has been moving a bit, yet dividends have risen since 2004 by 364% or equivalent to 8,4% on an annual basis. Note that Bayer decreased their dividend in 2020 from 2,80 euros to 2,00 euros reflecting the bad result in 2020. We also see that in 2018 Bayer paid out more than their result was for the year, looking a bit back that has a minor impact due to earlier years good results and lower pay-outs. If Bayer's EPS stabilizes to the average from 2004 to 2020 we would talk about an EPS of around 2,51 euros which sounds a bit low considering Bayer's normal business and operations. However, do understand why the stock is moving in the range of 46 to 49 euros.

Balance Sheet

Bayer's balance sheet will be discussed only briefly, will mainly focus on equity and goodwill per share as in 2020 their balance sheet ha more in goodwill then equity alone. 

Equity per share has grown well an equity ratio has displayed the same patter until 2014 were we see equity ratio drop from 40% to 29%. The reason behind the drop comes from 13,5 billion euros in acquisitions mainly funded by long-term debt. Bayer acquired Argentinian crops science company Biagro Group, Merck & Co Inc's consumer care business (largest acquisition that year) and Chinese Dihon Pharmaceutical Group. The graph clearly displays how equity ratio drops in 2014 while goodwill jumps to new highs. Still in 2014 Bayer had more in equity per share than goodwill per share which changed in 2020 due to the legal risk associated with RoundUp! legal claims mainly in USA. Note that the write-off of goodwill in 2020 has an impact both on equity as well as goodwill (a net zero game).

As 2018 shows we see the Monsanto goodwill impact with an all-time high in 2018.

I usually get worried if a company has more in goodwill than equity, goodwill if not real value is a risk factor for owners. It can be easily written down causing huge negative impact to shareholders and increasing the firm specific risk. I still see some risk of goodwill write-owns coming in Bayer's case yet limited in the long run.

Summary of Bayer AG

Removing the legal reservation and goodwill write-own in 2020, Bayer would have made a more normal net profit of around 4,5 billion euros and an EPS of around 4,59 euros per share. This is however just a simple calculation yet does not display the possible future cost from Monsanto. 

To summarize Bayer, I would not say it is under current circumstances a undervalued company. There are many risk factors associate with Monsanto that can have negative impacts in the future. Once these risk factors are taken care of then Bayer can proceed to making more normal results I would expect the net profit to land around 4 euros per share. Considering this if a bit in the future the current market price is fair.