Who does not seek them, the undervalued stocks that promise above-average returns? Well, the Bayer AG stock might be one of those. In this article, I will show you why the company is extremely undervalued at the moment, what upside potential it has, and what downside risks you should consider.
I have updated the article and included the results for the 2Q. I also published a detailed analysis of the numbers on Seeking Alpha (click here for the analysis).
Bayer AG is an international company in the pharmaceutical and chemical industry with a more than 150-year history that offers an extensive range of products and services, including health care and nutrition, as well as plastics and specialty chemicals. Bayer’s business contains three segments: Pharmaceuticals, Consumer Health, and Crop Science.
The Pharmaceuticals segment offers prescription products, especially for women’s healthcare, cardiology as well as specialty therapeutics for many areas such as hematology, oncology, or ophthalmology. In the Consumer Health segment, Bayer is mainly active in markets for nonprescription (so-called over-the-counter) products for dermatology, nutritional supplements, digestive health, cold, allergy, flu, etc. The Crop Science segment is after Bayer acquired Monsanto, the world-leading agriculture enterprise with businesses in seeds and crop protection. Bayer also has an Animal Health segment. This segment develops and commercializes products and solutions for the prevention and treatment of diseases in pets. However, Bayer plans to sell this part of its business shortly (see below).
Bayer AG valuation
Bayer AG is currently extremely undervalued. You can see this clearly from the chart below. To explain: The chart shows the correlation between the share price and the development of earnings (reported and adjusted), cash flow, and dividend yield. I take into account the data of the last twenty years to show the most extensive possible time. As you can see, the current share price is far below its present and future (end of 2020) fair value. It does not matter whether we look at profits, cash flow, or the dividend.
Merger thesis is still valid and supported by 2Q results
Bayer has presented quite stable figures for the Q2 2020. Revenue declined by only 2.5 percent. Furthermore, don’t let Bayer’s horrible EBIT of minus EUR 10.784 billion unsettle you. These are provisions for settlements built up in connection with the litigations involving Dicamba, Glyphosate, PCB, and Essure. Free cash flow amounted to a strong EUR 1.402 billion.
Q2 2020 has otherwise confirmed the merger thesis. The 3.2 percent growth in the Crop Science segment enabled Bayer to offset declines in sales of Pharmaceuticals (minus 8.8 percent) and Consumer Health (minus 1.9 percent). Adjusted earnings in the Crop Science Division rose by 28.4 percent to EUR 1.3 billion due to cost synergies from the merger and higher volumes.
The upside potential for the Bayer stock
Bayer’s current share price of under 56 EUR (on German stock exchange) is well below its fair value (side note: the all-time high is at 140 EUR). The difference to its fair value results in enormous upside potential for Bayer. If we look at what the fair value of the stock would be based on the historical average of the last 20 years for each multiple, the upside potential would be as follows:
- Adjusted earnings: 70 percent
- Cash Flow: 42 Percent
- Historical Dividend Yield: 83 Percent.
Evaluating the downside potential for the Bayer stock
Of course, every opportunity is matched by a corresponding risk. And at Bayer, there are even two significant risks. One is that Bayer is quite heavily in debt. The second risk is the legal problems the company is facing. Both risks are related to the acquisition of Monsanto. The company paid $62 billion in cash for the masterpiece of CEO Werner Baumann.
Bayer’s debt pile after the Monsanto acquisition
If we look at the current debt profile, the debt ratio is over 71 percent. That is too high in my eyes. The optimum for me is a value below 50 percent. I am also skeptical about the meager amortization power of just EUR 813 million per year compared to all debts (including liabilities) of EUR 88 billion.
But here we must put things into perspective. Due to COVID-19, the cash flow in 2020 is and will be very low. In the previous years the amortization power was much higher:
- 2016: EUR 3.7 billion
- 2017: EUR 2.9 billion
- 2018: EUR 2.2 billion
- 2019: EUR 1.6 billion.
By the end of the year, Bayer will also have already paid off EUR 9 billion of its total debt mountain since 2018 (more than 10 percent). The company’s rating is not the worst, either.
Besides, Bayer finally sold its animal health segment to Elanco for USD 7.6 billion. Elanco paid USD 5.32 billion in cash and the reaming USD 2.28 billion with shares. Bayer is thus concentrating on the Crop and Pharmaceuticals divisions.
Taking legal Monsanto risks into account
However, I do not think that the debt problem is the biggest problem for Bayer. The main risk lies in legal issues. Bayer has had to deal with massive lawsuits and has already suffered severe defeats. But then, Bayer announced a mega settlement of US$ 11 billion, which should have settled 75 percent of the ongoing proceedings.
Bayer wanted to pay between USD 8.8 billion and USD 9.6 billion to end the current proceedings, including a fixed sum to cover claims that have not yet been settled and an additional $1.25 billion for a separate agreement for potential future claims. Bayer planned to set up a scientific panel, while legal action should continue to be possible. The scientific panel would investigate whether or not the active ingredient in Roundup causes cancer. The critical point of the settlement for future lawsuits was that if the panel determined that glyphosate was not a carcinogen, then the members of the class action lawsuits would not be able to claim damages.
That settlement would have been a fair deal for Bayer shareholders. But then it became doubtful whether the settlement could be concluded in this way. The responsible judge expressed his skepticism about the proposed treatment of future claims. I still believe that in the end, there will be an agreement, as only the handling of future lawsuits is in dispute.
However, the failure of a settlement about future lawsuits will cause significant uncertainty. Shareholders react very sensitively to the development of the trials.
The number of lawsuits and the possible amount of damages in the US legal system could, at least theoretically, drive the company to ruin. Just a reminder: Three California juries already ruled that Bayer must pay billions of dollars in combined damages. Hence, as long as the settlement does not include future claims, things will remain rocky.
I will, therefore, follow the developments closely. Furthermore, I will not add any more Bayer shares to my portfolio to diversify my risks, even if the stock seems cheap. I already have enough Bayer shares in my retirement portfolio (about 4.5 percent of the total portfolio). That is enough for me.
Do you agree that the Bayer stock is undervalued?
Has Bayer caught your interest, or do you agree that the Bayer stock is undervalued? Be aware that attractive dividend yields should not be the only reason to buy shares of a company. The same applies to individual metrics such as PE ratio or P/C ratio. Always look at such numbers in context. My analyses here on the TEV Blog are an excellent way to start with your research (click here). You can also contact me here or ask the community in the comments if they can help with your due diligence.
Otherwise, I use tools like those from Dividendstocks.cash and Seeking Alpha to do further research. You can also find me and my analyses on these platforms.
Bayer is part of my diversified retirement portfolio. If you enjoyed this article and wish to receive other long-term investment proposals or updates on my latest portfolio research, you can easily follow me on
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