Fresenius stock: too cheap, measured by the sum of the parts (OTCMKTS: FMCQF)

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Thesis

I’ve had Fresenius SE & Co. KGaA (OTCPK:FSNUF, OTCPK:FSNUY) stocks in my portfolio for several years and have occasionally purchased additional stocks to lower my average purchase price.

I like the company serving and profiting from a megatrend in the form of an aging population. By the way: Fresenius is the only dividend aristocrat of the most important German stock index, the DAX, which means that the company has increased its dividend every year for at least 25 consecutive years.

Based on a sum of parts (SOTP) analysis and due to the low P/E ratio and strong growth prospects, I consider the company to be undervalued and therefore a solid buy. In particular, prices below 25 euros are in my view buy prices, which is why I almost doubled my position in the stock last week.

I have not yet purchased shares in Fresenius Medical Care AG & Co. KGaA (FMS/FMCQF), however, this company also appears to be undervalued.

In my view, the market is overpricing Fresenius Group’s short-term problems, which in turn offers opportunities for long-term gains.

FMC is also a buy, but I prefer the diverse bunch, which is purely a matter of taste. Hopefully the price will hit the twenties or even drop in the next few weeks. If that happens, I will buy even more shares.

business model

Fresenius is a leading, vertically integrated healthcare group with over 300,000 employees and a global presence in over 100 countries. The annual turnover of the previous financial year of 37.5 billion euros was achieved in 4 areas of activity:

Fresenius Group Overview

Figure 1: Presentation of the Fresenius Group (Presentation of the company Fresenius March 2022)

Fresenius Medical Care: The company is a global market leader in dialysis with approx. 345,000 patients in more than 4,100 clinics. Fresenius owns only about 32% of its subsidiary FMC. However, due to the control exercised, FMC is fully consolidated.

Fresenius Kabi: Kabi provides medicines and medical devices for infusion, transfusion and clinical nutrition. It is the main activity that was the focus of attention when the company was founded in 1912. The management is convinced that this activity will bring the greatest growth and the best return in the future.

Fresenius Helios: Helios is Europe’s largest private hospital operator with a 6% share in the German acute care market and 12% in the Spanish private hospital market.

Fresenius Vamed: Vamed is one of the world’s leading specialists in hospital services and projects. The company manages construction and expansion projects and provides services to healthcare facilities around the world. Fresenius owns only 77% of the shares.

The most important sales region is North America, especially the United States with a sales share of around 40%.

Difficult market conditions put pressure on share price

Even though the Corona pandemic is currently considered to be largely over, Fresenius and especially FMC are still suffering from the sequels and side effects of the pandemic such as:

  • Dialysis patients were particularly affected by Covid-19 due to their age and presented excess mortality, which is a major problem for FMC.
  • The pandemic is putting pressure on healthcare systems and health insurers, whose regulatory influences determine Fresenius’ cash-generating ability.
  • The American labor market has evolved strongly in favor of employees after Covid-19. It therefore became more difficult for Fresenius (especially for FMC) to find suitable employees at reasonable salaries.
  • The US government health insurance company Medicare only raises its rates with a delay of up to two years. In a phase of rapidly rising prices and therefore costs, Fresenius, like many other companies, is therefore unable to adapt sufficiently to inflation.

Do these headwinds justify the current share price?

I believe the capital market has overweighted the current issues and lost sight of the good long-term prospects and benefits of the company’s business model such as:

  • Fresenius good diversification along the value chain
  • Fresenius & FMCs sustainable companies that serve the macro trends of an increasingly aging population
  • The group and its subsidiaries economies of scale & synergies
  • Bargaining power of the group and its subsidiaries thanks to strong market positions in key regions and markets and the sheer size of the company
  • Strong long-term growth potential thanks to a good positioning in emerging markets

However, Fresenius Management is under pressure to regain the confidence of the capital market and the confidence of its largest and long-term shareholder, Else Kröner Fresenius Stiftung. The current dividend yield of 3.7% for both companies is really good for such stable business models, but of course not satisfactory without the corresponding share price performance.

Therefore, Fresenius wishes to refine its profile and is now pursuing the following strategy for its segments:

The main driver of Fresenius’ growth prospects is to strengthen the product side of Fresenius Kabi, historical core of the company. The company has therefore identified key objectives with its Vision 2026 initiative. As one of many milestones, Fresenius Kabi recently announced the acquisition of a the majority wins in mAbxience and the acquisition of Ivenix. – mAbxience strengthens Kabi’s presence in the high-growth biopharmaceutical market and Ivenix strengthens Kabi’s MedTech business (via a next-generation infusion therapy platform in the United States).

Considering the ROIC of the segment, which is far superior to the ROIC of others, the strategy seems reasonable.

ROIC of Fresenius business areas

Fresenius – ROIC of business sectors (Fresenius Annual Report 2021 p. 86)

For Helios and Vamethe direction of Fresenius is open to sell stakes. Possible is a sale of 20% of the shares of Helios to a Private Equity company to accelerate growth. According to Bloomberg, Helios is valued at $15 billion.

FCM, which is currently the biggest concern, will be reorganized to take advantage of efficiencies. A sale of the remaining shares currently seems unlikely to me, as FMC’s stock price is very low and Fresenius continues to stress that vertical integration is a strategic cornerstone of the company – at least in the short to medium term.

SOTP Rating Rates Fresenius as a Bargain

Therefore, I took the EBITDA of the four segments for 2021 and multiplied it by an appropriate multiple, which I took from the valuation master Damodaran. To check the plausibility of the multiples, I compared them with multiples from peers (if available) or other sources like rumors from the media (e.g. Helios rating).

After calculating the enterprise value for the first three segments, I subtracted the net debt for those segments to calculate the equity value, excluding FMC stock. To allow for a margin of safety, I used multiples and the most conservative values, when several reasonable values ​​were available.

Fresenius SOTP Analysis

Fresenius SOTP Analysis (Own representation)

Subsequently, I also evaluated the actions of FCM. Again, I saw a significant discrepancy between the current market value and the multiple-based valuation. FCM also seems to be undervalued for various reasons:

  • Equity value based on EV/EBITDA multiple less net debt at the end of 2021 is expected to be approximately $19 billion instead of the current market value of $10.9 billion, an increase of more than 70%.
  • The price/earnings ratio is also low at around 12x, even lower than when the Corona pandemic broke out. In my opinion, a realistic P/E ratio is between 16x and 18x, which gives more than 30-50% upside potential.
  • Even though many patients have died from Covid, which is truly a human tragedy, I see no reason for new patient peaks to be reached in the next few years. FMC continues to grow and people age.

The market seems to have overestimated the current problems of the two companies and punished the stocks too much. Moody’s obviously takes a similar view and recently FMC rating confirmed and considers the operational headwinds be temporary.

In the end, I added the two equity values ​​together (but took the current market value for FMC) and divided the final equity value by the number of shares and got a fair price (calculated cautiously) of around 46 euros for Fresenius, i.e. an increase of more than 80%.

Fresenius P/E ratio at an all-time low

Chart
FSNUF data by YCharts

To check the plausibility of the calculated value again, just take a look at the graph. Since the chart itself is very powerful, I will be brief: Fresenius currently has a P/E of 7x, which in my opinion is far too cheap given the growth outlook.

The level is about the same as at the start of Covid-19. Everyone can ask the question: When did the outlook and uncertainty in the healthcare sector worsen? Then or now?

Given the stable business model, I think a normalized P/E of 15x is plausible, which translates to more than 80% upside potential.

Conclusion

Fresenius and its well-known subsidiary Fresenius Medical Care appear significantly undervalued in view of my multiple approach (EV/EBITDA and P/E). Management has recognized this and wants to highlight the fair value of Fresenius. Given that I like the vertical integration of Fresenius much better than the pure dialysis business of FMC and that FMC has greater challenges overall, I give Fresenius a “Strong Buy” and FMC a ” purchase”.

The market may take some time to revise its assessment of Fresenius and FMC. Until then, we can expect a dividend yield of 3.7% for both companies, which I believe is very good value for such stable business models.

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