Company: Getinge AB ser. B (GETI B)
Written: Feb 2017
Authors position: Currently looking for a entry price around SEK 130
Overview of Investment Thesis
- Established companies with proven performance tend to produce superior returns compared to new firms and new industries.
- Basing their short thesis on short term thinking, The Street is currently betting heavily against the market veteran GETI.
- The current valuation almost represent zero future growth, which is very unorthodox considering GETI’s good track record.
- For the long term investor, who is comfortable with temporary red numbers, GETI provides an attractive investment opportunity.
- I advise a dollar cost averaging strategy as the current trend is downwards.
- The long term investor should not worry about the shorters, as lower prices increases future returns.
Examining the historical returns of S&P 500 proves that big pharma has delivered extraordinary returns to shareholders in the long run. Besides the strong consumer brands firms, the pharmaceuticals have a prominent place on the list of the best-performing companies from the original 1957 version of the S&P 500. What all these firms (Abbott Laboratories, Bristol-Myers Squibb, Pfizer and Merck) have in common are that they have built wide name recognition and consumer trust. They have survived and prospered over the past half century through significant changes in the economic and political climates, and virtually all have expanded aggressively into international markets. I believe the characteristics of these firms are very similar to that of GETI’s characteristics, indicating that the current sell off is unjustified and mistaken.
GETI’s Company history
In 1989, Rune Andersson and Carl Bennet made the deal of their life, buying GETI from the white goods manufacturer Electrolux. In hindsight, Electrolux (ELUX) made a huge mistake selling, as the company today represent around 50% of ELUX’s market cap. In 1993 GETI made its IPO on the Stockholm Stock Exchange. At this moment GETI had revenues of SEK 600 M, compared with todays SEK 30 BN, and a business that was solely focused on “sjukhus-diskmaskiner”, or translated “hospital-dishwashers” (to wash and disinfect / sterilize surgical instruments, etc.). This is thus Getinge’s origins and what today’s goes under the market section “Infection Control”.
In conjunction with its IPO, The UK sterilization company British Sterilizer and the French disinfection company Stirn Industries were acquired. Ever since, acquisitions have been a key element in building the GETI Group. In the wake of continued consolidation among health care providers, size is increasingly important for suppliers that want to achieve long-term success. Acquisitions still remain a key strategic element for GETI, particularly in order to continue to grow in emerging markets and to further strengthen leadership in certain segments.
*The acquisitions of AccuMed (SEK 66 M) and 1ST CALL MOBILITY LIMITED (SEK 233 M) is not included in the picture as they were completed in 2016.
Investing In The IPO of GETI Would Have Made Your Family Very Rich
Imagine that you had purchased 50,000 shares on the day of the IPO (back in 1993), writing a check for SEK 508,000 plus commissions to your stock broker. You stuck the shares in a vault, and ignored them for the past 23 years. How many shares would you have today? To calculate that, we need to look at the stock splits.
- year 2003: 4:1 split ⇒ 200,000 shares
As of today, The GETI stock is selling for ~SEK 140 per share. Your initial SEK 508,000 position would now be worth:
- 200,000 shares of the GETI stock with a market value of SEK 28,000,000
- Cash dividends, before taxes and inflation adjustments, worth approximately SEK 8,190,500. This significantly understates the dividend income because $1 in dividend income in the past had far more purchasing power than $1 in dividend income today.
- X amount of shares in Lifco AB ser.B, which was spun-off in 1998. I’m having problem finding data regarding how many Lifco shares were distributed to the shareholders etc. Assuming the shareholder would have directly sold the spin-off, I approximate the worth to be ~SEK 560,000. Notice that holding on to the spin-off would with most certainity produce a higher return as Lifco today is still alive (trading publicly for ~SEK 250/share).
- Grand Total: SEK 36,750,500 (CAGR of 20.5%)
GETI manage to outperform the S&P 500 by 1129 bp. To put the outperformance into context, your total net worth would have been SEK 3,842,541 (CAGR of 9.2%) if you would have put your money into the S&P 500 instead. GETI multiplied your dollar bills so extraordinary it makes “the feeding of the 5000” – a story of Jesus Christ using 7 loaves of bread and 2 fishes to feed five thousand people – look moderate in comparison.
*The diagram illustrates GETI and OMX dating back to 1993. Remember that the total return can’t be derived from a stock chart as a picture doesn’t reflect dividend and spin-offs etc.
The Bear Awakes
Despite its good track record GETI has fallen out of favor by the Swedish investment community in the last years. The stock peaked around ~SEK 245 in August 2013, and has since lost more than 40 % of its value. By comparing GETI to its peers group, we can clearly see the shift in sentiment. The white line represents GETI, and the Orange line represents GETI’s peer group (at least roughly). Ever since late 2013, the negative divergence between GETI and its peer group has started to grow, indicating that GETI is currently trading at a discount to its peers. The companies included as GETI’s peer group are STERIS PLC, Hill-Rom Holdings INC, MiMedx Group Inc, Top Glove Corp Bhd, VitroLife AB, AMBU A/S, Advanced Medical Solutions group, West Pharmaceutical Services, Hogy Medical CO Ltd and Grandhope Biotech Co Ltd.
*The diagram compares GETI’s EV/EBITDA multiple to its peer group.
*The diagram compares GETI’s price to book value to its peer group.
*The diagram compares GETI’s prices to earnings ratio to its peer group.
Depicting GETI’s EPS development in a diagram provides some insight into why the stock fell out of favor in 2013.
EPS peaked at SEK 10.61 in 2011 and has as of today decreased by more than 50%. Notice the somewhat odd relationship with EPS falling drastically, while Sales is growing with a CAGR of 6.4%. Comparing GETI’s Gross Margin and Operating Margin we can try to isolate the factor that is contributing to the EPS erosion.
Both the Gross Margin and the Operating Margin peaked around 2011 and 2012. The Gross Margin has been significantly more stable, as its only fallen with 600bp while the Operating margin has fallen with 900bp (Notice that the graphs are somewhat visually misleading, as they are not made in logarithmic scale).
The high gross margin of ~47% is characteristic for companies with high barriers to entry. The equipment GETI sells is subject to extensive inspections and quality controls and customers are willing to pay for proven quality. This makes the market slow to establish new competition and margins can be sustained. The fall in Gross margin from 52 to 47% can somewhat be contributed to the new alignment with the lower purchasing power of the emerging markets. In emerging markets, it’s a matter of increasing access to better health care with limited financial resources. Accordingly, products with simpler functionality at a lower price are becoming increasingly important in these markets. I expect the downward pressure on the Gross margin to continue, but only in a moderate fashion, as the Gross margin is still fairly protected. The lower Gross Margin will also be offset by higher volumes of sales from EM markets.
The main reason for the Operating margin falling so aggressively is because of restructuring costs. When adjusting for restructuring costs, the Operating margin has only fallen by 500bp, which is lower than the reduction in Gross margin. Increasing administrative expenses are also partially contributing to the lower Operating margin, as they are growing abit to quickly compared to Sales (9% AE compared to 5% in Sales between 2012-2016), but this is partially offset by the conservative growth in R&D (3%) and Selling expenses (3%).
Adjusting the EPS, by removing the restructuring costs shows a completely different picture compared to before. Instead of EPS being cut in half, it has only decreased by 7% from its peak in 2012.
Wall Streets opinion
The majority of investment houses derives their price targets by a blend of financial multiples like PE, relative PE and EV/EBITDA, etc. Because of the recurring restructuring charges, valuing GETI after similar earnings measurement is somewhat misleading. For instance J.P. Morgan recently published a sell recommendation, basing their valuation on the following numbers.
“Our P/E-based valuation uses a 12x 2016E multiple, representing a c40% discount to peers given the growth and risk profile, while our EV/EBITDA-based valuation uses a 8x 2016E multiple, a 25% discount to peers.”
Using this logic, the company indeed looks expensive, as the shares are trading on FY16 PER 27.9x and FY17E PER 15.9x on consensus forecasts, reflecting a big rebound in near-term profitability. As a rebound to organic sales growth from the contraction in FY16 might be uncertain, a price earnings ratio close to 30 looks overly optimistic. But adjusting the EPS, shows a different picture as the shares now are trading on FY16 PER 13.4x. I therefore recommend investors to look at the earnings with a grain of salt, and to value GETI after its expected future cash flows instead.
GETI reported FY16 results below consensus expectations. While organic revenues contracted 2.3% in Q4 16 and 1.5% in FY16, consensus is forecasting a return to organic growth of +1.7% in FY17, with the high end looking for +3.1% (Guidance is for ‘slightly positive organic sales growth). There is no margin guidance, but the company will see a SEK 200 M FX benefit and a SEK 50 M headwind from the consent decree (unclear whether this is one off or structural).
Overall organic sales growth at -2.3% is the second worst quarter since 2009 (only Q1 2016 was worse). This miss was driven by surgical workflows (-7.2%, and orders -9.2%). The decline was clearly noted in areas including Infection Control and Integrated Workflow Solutions, both of which posted strong fourth quarters in 2015. The organic order intake increased by 2.4% in Americas, mainly driven by positive development in the US. The APAC region reported a 5.5% improvement in organic order intake, with a particularly positive trend posted by Japan where Acute Care Therapies performed positively. The organic order intake in EMEA declined by 6.9%, primarily driven by weak performance in Surgical Workflows. The development in EMEA slowed growth for the Group as a whole. The most tangible decline in Surgical Workflows was in Northern Europe, the UK, DACH countries and Benelux.
To turn this trend around, within Surgical Workflows, GETI have taken actions to increase focus in the US amongst other countries and to strengthen their product portfolio. GETI will launch a large number of new products in 2017 and continue to develop their offering to their customers on the emerging markets. GETI expects to launch a large number of new products this year in the US.
As a result of the absent organic growth, shorts have piled into GETI in the last quarter, making GETI one of the 10 most shorted companies in Sweden. The bears concentrates on the “high level of debt”, change in management, likely dilution from P&PAC carve out and lack of further clarity ahead of the CMD in Q3. The new CEO does not start until May 2017. There is likely to be ongoing uncertainty around end market demand, particularly in the US. There is also likely to be lingering uncertainty on the cost base both in terms of potential additional regulatory costs and the carve-out of Patient & Post Acute Care. The company may continue to give limited guidance, citing these uncertainties (and leaving the new CEO to set his near and mid-term goals later in the year). The risk the bears see here is that the incoming CEO gets ‘kitchen-sinks’ expectations.
The madness of the crowd
When the trend of earnings has been definitely downward, the street will assign great weight to this unfavorable factor. The street will not assume that the downcurve must presently turn upward, nor can they accept the past average. But they will be chary about any hasty conclusions to the effect that the company’s outlook is hopeless, that its earnings are certain to disappear entirely and that the stock is therefore without merit or value. The value investor should take advantage of this behaviour. If the shorts keep piling into GETI, there will develop a very good long opportunity. Notice that GETI’s growth has historically been very cyclical, and that investors who have went against the herd and bought in down periods have been heavily rewarded.
GETI’s operations generate a steady stream of cash flows that far exceed the outlay of cash required to acquire or start it. This is what separates good businesses from great businesses. Great businesses that can turn sales into free cash flow usually have a competitive advantage that strengthens their future. The table below shows GETI’s cash flow profile for a typical year.
GETI uses most of its cash for M&A, which enables the company to grow at a pace exceeding their organic growth. This strategy is what has historically provided shareholders with the extraordinary excess return (CAGR of 20.5%). Another choice is to distribute the excess cash in dividends and/or buyback.
This is what Warren Buffet and Charlie Munger means when they say they want a shareholder friendly company. They want earnings that turn into cash, not more factories or inventory. They want cash cows, as most value investors do. GETI’s payout ratio is very low (17% of CASFP) as the board believes they can produce superior returns with their M&A strategy. To fully appreciate the size of CASFP in relation to GETI’s current valuation we can make a hypothetical example. Let’s assume that GETI converts into a mature company, and uses most of its excess cash to distribute in dividends. Let’s assume that GETI pays out 60% of CASFP (SEK 1,800 M), which is the same as 75% of Cash left for dividends &/or M&A. Using the Gordown growth model implies a SEK 189 valuation.
Gordon growth model: SEK 189
- Assuming a 60% payout ratio (0.6*CASFP)
- Requried rate of return of 7%
- Dividend growth of 3%
A more precise valuation is possible by using a DCF.
Bull case DCF model: SEK 255 (82% upside assuming bought at SEK 140)
- CAGR of ~6% for a 10 year period (the historical 10 year CASFP growth is 8%)
- Terminal growth rate of -2% thereafter.
- WACC of 7%
Base case DCF model: SEK 172 (23% upside assuming bought at SEK 140)
- CAGR of ~2% for a 10 year period
- Terminal growth rate of -2% thereafter.
- WACC of 7%
Bear case DCF model: SEK 120 ( -14% downside assuming bought at SEK 140)
- Terminal growth rate of -2% (into perpetuity)
- WACC of 7%