Why Has Bayer Performed So Poorly?
As a consequence of the Monsanto deal, Bayer was served a wave of lawsuits. The crop protection product "Roundup," originally provided by Monsanto, is suspected of being carcinogenic. Bayer has announced settlement agreements with most of the plaintiffs, but the topic is not yet finally closed in regard to future lawsuits. Bayer made provisions to cover the worst case, that the litigations cannot be settled.
Nevertheless, the company market price has dropped from about €111 per share to about €51 per share right now. The reason for this is a mixture of legal uncertainties and a loss of trust in management. Among shareholders, the meaningfulness of taking over Monsanto, considering the risks, is a hot topic. The representative for the deal was CEO Werner Baumann. The price of Bayer shares increased by 5% when Manager Magazine published an interview at the end of 2020 in which Mr. Baumann announced his resignation from Bayer at the same time as the Monsanto integration was finalized.
Moreover, there are persistent rumors about the company splitting into three divisions. However, CEO Werner Baumann and the chairman of the supervisory board, Dr. Norbert Winkeljohann, have rejected the notion of this.
Checking the Financials
To confirm the financials of Bayer, I have examined a few metrics. The observation period is 5 years, and the Monsanto deal is therefore included since 2018. The financials used in this article are highlighted.
Starting with the consideration of their growth, Bayer's sales show a slightly positive trend. On average, the sales grew 4.62% per annum. The major growth results from the years in which Monsanto was included in the company. In 2020, Bayer could not continue this trend, but this is as a consequence of the COVID-19 pandemic. In addition, the sale of the Animal Health division in 2019 influenced the financials. For the reason of the allocations to provisions and the impact of the depreciation and amortization of the Monsanto deal, I will evaluate the EBITDA before special items as a better indicator of operative growth. The EBITDA before special items shows a positive trend with an average 5.75% gain.
To move on to profitability, the EBITDA margin is very stable at about 24% to 28%. At this point, it is relevant to form an idea of the net income in the case that there were no allocations to provisions. In Bayer's annual report, it says the following:
The balance of other operating expenses and other operating income amounted to minus €15,373 million (2019: minus €374 million). This figure reflected in particular the allocations to provisions in connection with the glyphosate, dicamba, PCB and Essure™ litigations as well as the impairment loss on goodwill in the Crop Science Division.
With an accounted net income of minus €10,495 million, I will go with an estimated net income without the Roundup lawsuits of about €4,700 million. So, the estimated Return on Equity (RoE) is at 15% and the estimated Return on Assets (RoA) is at 4%. You can see the RoE is okay, especially if you have a look at the years 2016 and 2017, there is hope to achieve higher numbers in the future. When looking at the sinking equity, the high RoE in 2020 isn't that meaningful (more about this later). The RoA shows that the achieving of the net income is very capital-intensive. One reason for this is high goodwill and intangible assets positions in the balance sheets because of the Monsanto deal.
To evaluate the risk, I want to start with looking at the gearing. Resulting from the negative earnings impact in 2020 (€10.5 billion), dividend payments (€2.8 billion), and negative currency effects (€3.5 billion), the shareholders' equity dropped about 36%. So, the gearing raised from 72% in 2019 to 98% in 2020. The equity ratio fell to 26%. From a risk perspective, these are not good signs. Considering the metrics below that show the last 5 years, the rising risk is relativized by both gearing and equity ratio.
Calculations of the risk metrics
Calculations of the risk metrics based on Bayer's financial reports (Author)
As an interim conclusion, the risk of Bayer is rising due to an exchange of medium to low growth and medium profitability.
A Closer Look at the Last and Future Quarters
Before getting to a valuation, I want to review some estimates for sales and EBITDA by looking closer at the most recent quarters. On MarketScreener, the following estimates were published:
Bayer AG estimates
Estimates for Bayer's future financials (MarketScreener)
To check the legitimacy of these numbers, I want to start with the year 2021. The numbers of the first three quarters are known, so it is possible to compare these quarters and the estimated Q4 with the numbers of 2020:
Last quarters results and estimations for Q4 2021
Last quarters results and estimations for Q4 2021 (Author)
As per the net sales, EBITDA and EBIT stayed at nearly the same point as last year in most of the last quarters, therefore, I think the estimated numbers for Q4 2021 are legitimate. The net income starts to grow again because most of the allocations to provisions are already held back. Furthermore, the growth rates for the next two years (2022 and 2023) are not far away from the growth achieved in the past.
With the above knowledge of the historical financials and the legitimate estimates, I will provide you with a possible valuation of Bayer from my point of view. At the time this article was written, the share price was about €51 and there were 984.42 million shares outstanding. Thus, the market capitalization was about €50.2 billion, less than Monsanto was acquired for.
To get to a valuation of the Bayer portion, I want to relate the enterprise value to the sales and the EBITDA before special items, because a lot of the financials are influenced by the Monsanto problems. You can find my calculation in the following depiction.
Calculations of future multiples based on the financials and the estimates
In addition to the risks already mentioned, I would like to briefly summarize the opportunities again:
Market leadership in a megatrend
After the Monsanto integration is done, it could change everything for the better
If the lawsuits are settled, a lot of pressure will fall off of the stock
To complete my thesis, I think the actual price is a good entrance point for people who want to get their hands on a company that probably could become enormously important in the future, and as a result trade at higher multiples with higher income. But for me as a shareholder, it is only a hold situation due to the black box of Monsanto that delivered not as much as expected, except problems. If the long-term trend starts getting confirmed by the numbers, I see big potential in Bayer stock.