Description

Stevanato Group (STVN) is a provider of pre-sterilized drug containment solutions. Founded in Italy in 1949, Stevanato manufactures custom-formulated, mission critical drug delivery systems (e.g., vials, syringes), with significant leverage to the fast-growing biologics market.

We view Stevanato as an integral player in the drug delivery market with a structurally improving share position in a large and growing industry segment, trading at a meaningful discount to fair value given misplaced concerns around the importance of COVID-19 vaccine-related revenues and bioprocessing inventory risk.

Accelerating growth in biologics should drive increased demand for Stevanato’s solutions. The past decade has seen an acceleration in the pace of biologic (large molecule) development, as can be seen from the emergence of the modern “biopharma” industry and the consistent increase in the pace of biologic approvals by the FDA. In 2022, biologics represented more than 45% of FDA new drug approvals, nearly twice the 10-year average of 26%, and biologics now represent an estimated 45% of the biopharma R&D pipeline vs 35% 10 years ago.

In contrast to traditional small-molecule treatments, biologics physically interact with their storage environment, and thus require complex containment solutions to ensure drug quality. Stevanato provides these mission critical products, working in tandem with biopharma firms to create qualified, unique solutions to store finished drugs. While its products account for a low single-digit percentage of a finished drug’s cost, the cost of a container failure that would ruin a drug is extremely high, resulting in market share aggregating towards established providers like Stevanato. The sole- or dual-source nature of these products also provides producers with strong contract protection and meaningful pricing power. For example, Stevanato was able to fully pass natural gas cost inflation on to its customers in 2022.

In the past, large pharmaceutical firms often developed containment solutions in-house, operating large facilities to perform the required sterilization and coating of vials and syringes. Stevanato’s solutions provide its customers with a bespoke, “ready-to-fill” storage offering at a meaningfully lower cost (industry contacts estimate a greater than 45% cost reduction relative to in-house production). For Stevanato, “ready-to-fill” offerings make up the bulk of the company’s “high-value solutions” (HVS) portfolio, bespoke products which are the most complex within Stevanato’s suite of products. HVS margins are more than twice the corporate average, with the company’s highest priced offerings generating gross margins as high as 70%. Fueled by biologics market growth and Stevanato share gains, HVS revenue has grown from ~10% of sales in 2016 to 30% as of 3Q22. The company is targeting HVS revenue to be 35% of its total business by 2026, and we see scope to achieve this goal as early as late 2024 as new capacity expansions significantly increase HVS production.  

Multiple idiosyncratic drivers. In addition to biologics market growth, we believe Stevanato is positioned to benefit from several company-specific tailwinds. We estimate that EPS will compound at a double-digit CAGR over the next five years from this combination of market and idiosyncratic growth drivers.

·         Increasing vial penetration. As discussed above, there is a secular shift towards “ready-to-fill” containment solutions driven by increasing treatment complexity and a push by biopharma companies to lower costs. While more than 90% of syringes currently come in a “ready-to-fill” format following a 20-year period of increasing market penetration, the story has only recently begun for the larger vial market, where penetration currently sits at less than 5%. Stevanato is the market leader in vials with roughly 50% share and is credited with igniting the push towards “ready-to-fill” solutions in the space. While penetration will take time given the high switching costs for existing products and a risk-averse customer base, we expect “ready-to-fill” penetration to increase steadily over the coming years, with our primary research pointing to pre-sterilized vials growing at twice the market rate over the next decade.

·         Syringe market share gains. While Becton Dickinson pioneered the “ready-to-fill” syringe market, Stevanato has been steadily taking share and now sits as the clear number two in the market with over 10% share. Per our customer checks, Stevanato differentiates itself by engaging with customers early in the drug development process (working with customers years ahead of production to develop solutions) and offering a nimble, modular manufacturing approach. We expect Stevanato to continue to gain share in the syringe market in the years ahead.  

·         Capacity expansion. Stevanato used the proceeds from its 2021 IPO to fund capacity expansions in Italy (currently ramping production), the US (production start 2023), and China (production start 2024), while maintaining a net cash balance sheet. These facilities will give Stevanato a HVS production footprint in all major drug development and manufacturing markets, which will allow the company to benefit from efforts by drugmakers to localize supply chains following the COVID-19 pandemic. We are particularly positive on the company’s new plant in Indiana, which is currently under construction. While Stevanato does not disclose specific customers, our conversations with industry experts indicate that the plant should ramp quickly on strong GLP-1 demand from Eli Lilly (LLY), whose corporate headquarters is less than 20 miles from Stevanato’s new facility. Eli Lilly is the developer of Mounjaro, which is expected by many to be the largest drug launch of all time pending FDA approval for the treatment of obesity in 2023. We expect that the production of Mounjaro will rely heavily on HVS products manufactured by Stevanato.

We believe short-term concerns are overblown. STVN shares have been held down by broader investor concerns around COVID-19 “over-earners” in the life sciences industry and excess inventory at companies engaged in bioprocessing. We view both risks as overstated and more than fully discounted in the current stock price.

Stevanato is a major provider of delivery systems for the Pfizer and Moderna COVID-19 mRNA vaccines, with COVID-19 vaccine-related business expected to account for ~10% of revenue in 2022. We expect this revenue stream to decline 60% in 2023 and another 20% in 2024, moving to just 3% of revenue in 2024. While consensus expectations broadly factor in this magnitude of vaccine-related revenue declines, incessant sell side focus on vaccine exposure has led investors to ignore very strong trends in the non-COVID business. While not reported separately by the company, our analysis indicates that Stevanato’s non-COVID backlog has grown by nearly 40% over the past 12 months, with a book to bill of approximately 1.2x. Amazingly, even with the precipitous drop in COVID-19 vaccine-related orders experienced in 2022, total company book to bill remained above 1.0x. Importantly, because vaccine-related revenue carries a lower margin than HVS offerings, Stevanato experiences an uplift in margins as this revenue declines and the company fills former COVID-19 vaccine-related production lines with other HVS products. Unlike some of its peers, Stevanato’s execution during this transition has been strong as the company has not experienced any issues converting manufacturing lines away from vaccine-related products.

Stevanato has also been dragged down by investor concerns around excess inventory at companies engaged in bioprocessing as demand for COVID-19 vaccines has declined. We believe these concerns are unfounded for Stevanato’s offerings as they are specified for use in certain products and not fungible, limiting the risk of inventory build seen in other areas of the production chain. In fact, companies across the ecosystem (West Pharmaceutical Services, Eli Lilly) have pointed to the opposite problem in the high-end container space, with the lack of available production capacity currently seen as the gating factor on market growth. Stevanato’s recent shift to 24-7 operations and decision to accelerate the expansion of its Italian plants support this view.

We think investors are overly concerned with what our research indicates are immaterial risks and we believe consensus estimates fail to appreciate the magnitude and duration of Stevanato’s multi-year growth runway and expanding profitability. We see more than 15% upside to consensus EPS estimates in 2024 and beyond.

Key risks. We are confident in the structural drivers underpinning Stevanato’s long-term growth but do see several company-specific risks worth monitoring. Stevanato has executed well as it has transitioned production away from products tied to COVID-19 vaccines, but peers like West Pharmaceutical Services (WST) have struggled to convert, qualify, and fill production lines tied to COVID-19 products, resulting in several quarters of depressed earnings. While similar issues would not change Stevanato’s earnings power over the medium- to long-term, they could illicit a negative short-term share price reaction. Stevanato is currently in the process of building two new production facilities in countries outside its home market. Construction to date has progressed according to plan but given tightness in global supply chains and construction markets, it is possible the company encounters issues that lead to production delays. Finally, the Stevanato family owns 78% of the company and controls 95% of votes through its ownership of Class A shares, which confer three votes per share. As long-term shareholders, we are aligned with management’s multi-generational time horizon and approach to investing in the business (Executive Chairman Franco Stevanato is a third-generation descendant of the company’s founder), but we are also cognizant of the governance and liquidity implications of family control.

Valuation. Despite the strong fundamental set up, STVN has stubbornly traded at a discount to life sciences companies with similar profiles. The stock currently trades at approximately 17x our 2023 EBITDA, well below WST and other peers that trade above 20x. We believe the discount stems from Stevanato’s shorter history as a public company and its depressed free cash flow conversion, the result of heavy spending on HVS capacity expansions that we estimate will generate returns on capital of more than 20%. On our estimate of normalized 2026 free cash flow (after the construction of its plants in Italy, the U.S., and China are completed and ramping production), shares are currently trading at a 5.5% FCF yield, which we believe is attractive for a company with a strong growth profile, non-cyclical end-market, and net-cash balance sheet. For context, WST has not traded at a FCF yield above 3.2% at any point in the past decade.

We see strong parallels between Stevanato and West. West has a near-monopoly in rubber stoppers used in drug delivery, a product that shares many of the same characteristics as Stevanato’s offerings (highly specified, mission critical), but that is further along the adoption curve. If we remove the noise created by COVID-19, over the 10-year period from 2009 to 2019, West’s high-value products increased to 42% of 2019 sales from a negligible amount in 2009. As a result, over the same period, West’s EPS compounded at a 14% rate, its P/E multiple expanded 250%, and its shares increased at a 25% CAGR. While there are some modest differences between the two companies, we think Stevanato is highly comparable to West during an earlier stage of its evolution. Supporting this view, the former CEO (2002-2015) and CFO (2003-2018) of West who championed the company’s push towards high-value products both sit on Stevanato’s Board of Directors.

Assuming a free cash flow yield in the 3.0-3.5% range by the end of 2025, which equates to a yield of 3.5-4.0% on 2027 FCF once production in its new plants is fully ramped, we see approximately 70% upside for STVN shares over the next several years.

This report (the “Report”) with respect to Stevanato Group (the “Issuer”) has been prepared by the author (the “Author”) for informational purposes only. The Report contains certain forward-looking statements and opinions which are based on the Author’s analysis of publicly available information believed to be accurate and reliable. While the Author believes that such forward-looking statements and opinions are reasonable, they are subject to unknown risks, uncertainties and other factors that could cause actual results to differ materially from those projected. The Author has no obligation to inform readers of changes in such forward-looking statements and opinions and no warranty is made with respect to the accuracy or completeness of any of the information set forth herein.

As of the date the Report is published, the Author and/or certain entities (the “Entities”) affiliated with the Author hold a long position in the securities of the Issuer and therefore have a financial interest based on changes in the price of the Issuer’s securities. The Entities may increase, decrease or otherwise change their position in the securities of the Issuer based on changes in market conditions or other analysis. Neither the Author nor the Entities undertake any responsibility to inform readers of changes in such position.

Nothing in this Report constitutes investment advice. Readers should conduct their own due diligence and research and make their own investment decisions.

Catalyst

• Earnings revisions
• Multiple re-rating, partially closing the gap with WST.