Description

Company Background:

Sartorius is a German Large-Cap with about 20 billion in market cap. The company is a DAX member, as well as TecDax and specializes in supplying the biotech- and pharma industry.

Sartorius’ history reaches back into the 19th century. They started out primarily as an equipment producer for laboratories e.g. weighs and filters. This business now called (LPS) still accounts for around 25% of Sartorius sales. The bigger business today, which has come via an acquisition of Stedim Biotech in France, revolves around bioreactors, and is called the bioprocessing product & services segment (BPS). This accounts for 75% of the revenues of the business.

Together the two main divisions account for roughly 4 billion euros in sales with an EBIT margin of 22% in 2022. Both business divisions have an excellent structural growth with the market for LPS expected growth at 5% p.a. and BPS expected to grow 11% p.a. until 2030, according to a recent study from a third party. Especially looking at the BPS business, Sartorius Stedim Biotech is the leading producer of single use bioreactors and associated equipment, which is a technology that is supplanting the current modality of multiple use Steel based bioreactors (I provide more detail later on), and hence a rapidly growing market. Sartorius thus fits the criteria of a dominant player in an industry that is growing by over 10% p.a.

Sartorius AG: We think it is a High Quality Business with Structural Growth.

First, Sartorius is a highly quality business with a strong moat:

Sartorius AG, through its Stedim Biotech business is market leader in single-use bioreactors for the production of biologics. As an innovation, in order to reduce the enormous cost of cleaning bioreactors and reduce contamination risk for small batch drug/biologics production and make that economical, Sartorius pioneered the use of one-time use bioreactors. How it works is that rather than having to thoroughly sterilize the traditional steel bioreactors, Sartorius solution using a specialized container and adapted bioreactor can simply be discarded and replaced with a new container after a biologics production run.

Typically, such a container or bag lasts for up to 2 weeks, which fits well into ordinary batch production cycles. Customers have several advantages:

• Circa 30% lower construction cost for manufacturing facilities
• Circa 60% lower energy/water cost
• High flexibility
• Circa 40% faster time to market
• Lower contamination risk
• Time and cost efficient for small-batch production

For Sartorius, the business provides wonderful qualities. First, it is a razor razorblade model, where consumables are sold for high margins. Moreover, in this highly regulated market, big pharma companies, once they commit to using the bioreactors from Sartorius Stedim cannot readily move or change their production process to a different solution. A high quality solution as Sartorius has provided for many years and that is familiar to the customers have both a high switching cost and fundamental reasons why churn is very limited.

Moreover, as the cost for producing biologics i.e. bioreactors is also a relatively small fraction of the cost of the overall value delivered by the biologics/pharmaceuticals that are produced and they equipment used directly affects yield, customers do not have a primary incentive to save costs through purchasing the cheapest available bioreactors. Hence, the price pressure in this industry has always been moderate and allows Sartorius to make decent margins. Historically EBITDA margins of Sartorius’ BPS business has been around 32%. 

Lastly, One-stop-shop suppliers are very popular among pharma companies and laboratories because they offer integrated solutions. Sartorius sells every product along the whole value chain in drug manifacturing. They can also provide you with laboratory items to go alongside manufacturing equipment - pipettes, weighs, filtration flasks and so on. You get everything out of one hand.

Sartorius is expected to continue to grow its business at a high rate for the next decade and more:

Historically Sartorius was able to grow revenues at 17% p.a. and earnings at 30% p.a. over the last 10 years respectively. We believe this will continue in both the LPS and BPS divisions.

Over the last 10 years, more and more drugs have been launched using antibody drug conjugates (ADCs). Combined with ever increasing need for personalized medicine including therapeutics that are increasingly targeting specific patient populations, the drug industry is moving more towards smaller batch production than in the last decade.

This is expected to accelerate in the future, and Sartorius’ single use bioreactor solution is an ideal solution fitting with this trend compared to traditional multi-use steel bioreactors.

We expect demand for single use bioreactor capacity should increase with a CAGR of around 13% for the next 4 years. We believe due to the superior quality of Sartorius Stedim’s products and their underrepresentation in the US market and continuing market share gains, a forward growth of 16% p.a. for the next 5 years (after the recent destocking cycle) would be reasonable for the company.

From the same third party study, the expected Total Addressable Market (TAM) for Sartorius is estimated around €40 bn, split up into 2/3 BPS and the remaining 1/3 LPS.

Ultimately, we believe that Sartorius can structurally maintain the mid-teens growth rate that it has seen in the last decade over the next 10 years. We believe that due to the high returns of the business, and the large market that is still to be developed, the company will be a wonderful compounder for many years into the future.

Risks to our assessment:

Competition:

The BPS market is rather fragmented. There is several subsegments where different players specialize in. The Single-Use-Container and -reactor market is a stable oligopol with four players controlling 70-80% of market share. Stedim is the biggest one accounting for 35-40% in both reactors and containers. Market share seems to very sticky for established players. Market trend shows that big players gain market share from smaller suppliers.

It seems to be difficult to enter this market. Chinese companies are large buyers of these products, yet no Chinese manufacturer has emerged in this area implying, that it is quite tricky to produce single-use-products (there is no major patents). This obviously holds risk, since it could change in the future. Since again, no patents secure Sartorius products, competitors could try gaining market share in less regulated countries like China e.g. That would affect growth or margins if price pressure occurs from these new competitors.

Sartorius now trading at attractive levels

Recently Sartorius’ share price has dropped significantly. During the pandemic, price peaked at  around €780 per share. That was heavily inflated by Covid-Sales. Sales increased by 47,5% in 2021 since many pharma companies were stocking up their inventory to be able to produce in spite of stressed supply chains. Consequently, orders in the past two years fell. I believe this is a exceptional one-time situation and not indicative of a structual decline. We expect that after pandemic inventories are once again consumed, order volumes should reverse back to normal thus higher levels.

It now trades at around €250 per share for the ordinary shares (SRT.DE), and the P/E ratio is at around 30x sustainable levels. I see this as a great opportunity to invest in a exceptional quality business at an attractive valuation level. A valuation level that we have not seen with Sartorius since 2016-2017. Please note that the below valuation i.e. share price is based on the preference shares traded under (SRT3). The preference shares are much more liquid and more appropriate if you are working with larger sums of capital, but otherwise the ordinary shares trade at a discount.  

Catalyst

A rare opportunity to buy a structurally growing business during a temporary period with negative growth and lower than average valuation for the company.