Description
Thesis:
Gerresheimer AG (GXI GR) is a high quality, defensible pharmaceutical packaging business (test tubes, syringes, inhalers etc) in a secularly growing market that we believe is not being valued appropriately by the market due to prior hiccups in the business that unnerved an investor base who expected more stability. As management delivers and earnings beat expectations, we feel the multiple will expand to a level that more accurately matches the business quality and growth profile.
We feel GXI should be able to grow by ~20% per year over the next two years earning $3 in EPS in 2012, beating street estimates, and as the business continues to distance itself from hiccups in 2009 it should get a 15x multiple, implying a $45 stock, or 35% upside. In a more bearish scenario, we see downside of 10%, or 12x 2012 of $2.50 in EPS. GXI was previously owned by private equity before IPO'ing at $40 in mid-07. Given all the cash PE funds need to invest over the next 12 months GXI could be ripe for a take out.
Business description.
A brief primer is below, but please refer to the previous write-up by will579 in Dec 09' for more background info on the business and the 2009 hiccups.
Gerresheimer sells glass and plastic pharmaceutical packaging solutions. Their focus is on specialized niche applications such as pre filled syringes, inhalers and vials. The company has four main divisions:
- Tubular Glass (30%): High-quality glass syringes, medicine vials, ampoules and cartridges
- Plastic Systems (31%): Inhalers, pens systems, plastic bottles and diagnostic equipment
- Moulded Glass (30%): Pharmaceutical bottles and jars, injection, infusion and transfusion bottles
- Life Science Research (9%): Test tubes, pipettes and flasks
Competition:
We feel ~80% of GXI business is niche, offers high barriers to entry, and only 3-5 players with limited price competition. For instance, only 5 companies in the world can produce tubular glass to FDA specs and GXI / Schott have 75% WW share, and GXI is likely taking share. The other 20% represents more commodity like businesses lines. Peers that trade publicly are Beckton Dickenson and West Pharma.
Industry / business quality:
Pharmaceutical packaging appears to be a very attractive industry from a structural perspective. Packages are often designed in to the product's regulatory life, are priced low relative to the product ASP, involve high switching costs, and volume predictability.
Small % of end product cost - A pre-fillable glass syringe costs ~$1.00 vs. a dose of a biologic drug which could cost $500. An auto-injector for a cancer drug might cost $5.00 vs. $200-$300 for a dose of the drug.
FDA approval process makes switching costs very high - Drugs are approved by the FDA in conjunction with a specific packaging solution. This is because many drugs will interact with the packing, and this interaction explains why glass is so prevalent in the industry (it's inert). Pharma companies will often qualify two packaging suppliers during the approval process, although they'll sometimes single source if the expected unit volume is small. Qualifying another packing solution down the road would require the Company to "open the file" with the FDA. This introduces a multitude of risks, the direst of which is the discovery of a safety concern with the drug itself. Pharma companies are extremely reluctant to qualify further suppliers.
Performance and reliability are essential - Advanced drug delivery systems need to work EVERY time. This reduces the incentive for a customer to risk working with an up-and-coming supplier.
Predictable and healthy end market growth characteristics - The core demand driver is increasing worldwide adoption of drug therapies. Access to healthcare is improving around the globe, new medications are introduced every year, vaccines and biologics are increasing in prevalence, etc. Layer on top of this increasing penetration of advanced injection systems and you have a mid-high teens growth trajectory for the foreseeable future.
Misperception:
Growth potential, business quality, stability of business in all but a sudden downturn like 09'
Mgmt recently shut down an RTF line to quality a new product, which will impact Q4 and Q1 and could be weighing on stock. But, LT positive.
Growth drivers:
While the majority of their business lines offer modest growth potential, we foresee extremely strong growth potential for Gerresheimer's "injection systems", a category encompassing pre-filled glass syringes and plastic inhaler and pen systems, among other things. We believe this represents 25% of Gerresheimer's revenue and will grow at a 15% CAGR for the foreseeable future. We also believe the high fixed cost nature of glass manufacturing (~90% fixed cost) will afford the Company substantial operating leverage as demand strengthens (current capacity utilization = low 90%s vs. a normal 95-100%)
Earnings beat:
We think the street under appreciates the top line growth and operating leverage within the business, which could lead to a strong EPS beat.
Recent meeting with management:
Business demand seems robust and they expressed interest in reinstating dividend, subject to a board approval in April.
Valuation:
Upside. 2012 EPS $3 x 15 = $45
Downside. 2012 EPS $2.50 x 12 = $30
Catalysts:
Earnings beat
Distancing itself from 2009 hiccups
Market appreciation for quality of the business
Reinstate dividend of 25-30% of net income, subject to an April board approval
Disclaimer:
We and our affiliates are long Gerresheimer (GXI GR), and may long additional shares or sell some or all of our shares, at any time. We have no obligation to inform anybody of any changes in our views of GXI. This is not a recommendation to buy or sell shares.
Catalyst
Earnings beat
Distancing itself from 2009 hiccups
Market appreciation for quality of the business
Reinstate dividend of 25-30% of net income, subject to an April board approval