Steady progress, expected acceleration

Stratec Biomedical 2 November 2015 Update

Stratec Biomedical

Steady progress, expected acceleration

Q315-2017 perspective

Healthcare equipment &
services

2 November 2015

Price

€48.70

Market cap

€577m

Net cash (€m) at 30 Sept 2015

49.5

Shares in issue

11.85m

Free float

58%

Code

SBS

Primary exchange

Frankfurt

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(13.8)

(2.5)

13.1

Rel (local)

(7.6)

11.2

4.9

52-week high/low

€54.5

€35.5

Business description

Stratec designs and manufactures OEM diagnostic instruments. It is profitable with a global reach and a strong order book with five key clients. Design and assembly of systems from modules is in central Germany and Switzerland with a Chinese facility being developed. A US subsidiary has advanced optical technologies and there is a UK middleware company and a DNA business in Berlin.

Next event

FY15 annual report

April 2016

Analysts

Dr John Savin MBA

+44 (0)20 3077 5735

Dr Philippa Gardner

+44 (0)20 3681 2521

Stratec Biomedical is a research client of Edison Investment Research Limited

Stratec, the German designer and builder of automated OEM diagnostic systems, is poised for rapid growth in 2016 and 2017 due to the intensive level of activity on new systems in the late-development and pre-launch, ramp-up stages. A new development area of liquid cancer biopsy analysis is being developed plus smaller, flexible systems. Revenue CAGR guidance remains at 8-12% for 2013-17, so growth should be stronger from 2016. Management expects FY15 EBIT margin over 17.9%. It is considering acquisitions that may affect dividends; Q3 cash was €54.7m.

Year end

Revenue (€m)

EBIT*
(€m)

EPS*
(€)

DPS
(€)

P/E
(x)

Yield
(%)

12/13

128.0

19.5

1.8

0.60

27.1

1.2

12/14

144.9

24.1

2.2

0.70

22.1

1.4

12/15e

148.4

26.7

2.3

0.70

21.2

1.4

12/16e

165.2

30.6

2.5

0.70

19.5

1.4

Note: *EPS is normalised, excluding intangible amortisation, exceptional items and share-based payments. EBIT, which is stated as reported, is the focus of management guidance. DPS relates to dividend declared for that year but paid in the subsequent year.

Design them...

Stratec projects require software, engineering and electronic expertise with systems becoming more complex; Stratec retains critical IP. The emerging liquid-biopsy diagnostic area is one of several new development activities. In 2015 ytd Stratec incurred €15.8m of development expenditure and capitalised €10.2m. Capitalised amounts are recognised as revenues as projects progress. Stratec plans to expand its development activities due to client demand.

...build them – and then sell service parts for them

System sales ytd were lower than management expected due to some placement weaknesses by partners in Asia. Service part sales are reported to be improving. The UK middleware subsidiary is doing well. Total revenues in 2015 ytd were up 1.8% to €107.2m. Stratec generated a higher gross margin of 37% ytd vs 34% for FY14. This was due to increased purchasing efficiencies; however a lower level of development revenue recognition and increased service part sales might have helped.

Valuation: Growth expectations

Management guidance of an 8-12% CAGR over 2013-17 implies 2017 revenues of between €174m and €201m. The bulk of the growth from 2016 must come from new system launches, growth from recently launched products and from a rise in development project activities; this will also increase headcount and costs. EBIT margin ytd was 17.9% and is guided by management to exceed this for FY15. On our revised EBIT expectations the current share price implies a prospective 2017 P/E of 18x. Stratec has generally traded at a historic P/E of about 24x. Management has indicated that major strategic acquisitions are being considered. This may affect future dividend payments.

Innovation and quality

Stratec designs and manufactures highly automated, customised OEM clinical diagnostic systems. It also supplies software and provides service parts. The top 20 global diagnostics companies have sales of $47bn. Of these, 13 (combined sales of nearly $26bn) buy Stratec systems. Two others buy workflow software; a major new software contract was signed in April 2015 and the UK-based middleware company is now making a positive contribution.

The investment case is based on Stratec’s embedded position in the global diagnostics industry. Clients enter a development contract for a customised instrument system adapted to their diagnostic test chemistry and market. Projects are a close co-operation effort. Stratec has skills and IP in immunoassay, haematology and molecular diagnostics, and is now evaluating a new test type involving circulating tumour cells (CTC), a way of detecting and characterising cancer. Software is a crucial part of the design and maintenance process.

Once launched, clients buy built-to-order systems (often under long-term contracts) and place (lease or sometimes sell) systems with their customers. There were 2,719 system sales in 2014; unit sales are only disclosed in the annual report. Units will have a market lifespan of up to 10 years, so need service parts and software upgrades. Stratec sells service parts to its clients so the size of the installed base, about 12,000 at the end of 2014, is a key EBIT driver. Complex systems form a larger part of Stratec’s sales mix. These require more service parts.

Stratec’s headquarters and main development centre is located in the Black Forest area of central Germany, near Karlsruhe. This site also manufactures systems, especially new products in the launch phase. A Swiss subsidiary manufactures established product lines and benefits from good infrastructure and tax rates; this operation is being expanded with a new building opening in H116. There are two other subsidiaries integrated into manufacturing and development. A US subsidiary has a speciality in optical measurement systems. A Romanian subsidiary develops instrument software and is being expanded further in 2015-16 with a new building. Stratec has strong client demand for its development services and is planning to expand these with additional staff.

Outlook on growth guidance

Stratec management has given average revenue CAGR guidance of between 8% and 12% until 2017, based on 2013 revenues of €128m (Exhibit 1) and extrapolating from signed contracts. As of Q315, management is confident that this guidance appears robust.

Exhibit 1: Projected revenue and EBIT growth

Source: Stratec management guidance, Edison Investment Research (EBIT and sales forecasts). Note: Error bars show revenue CAGR trend ranges at 8% (low) and 12% (high) based on 2013.

This guidance indicates a 2017 revenue range of €175-201m. To achieve this, growth in 2016 and especially 2017 needs to be at least 10%. Note that there is always a large element of revenue recognition from development projects and management expects this element to increase in 2016 and 2017.

Stratec has several ongoing development co-operations. On completion, these investments will be amortised based on expected system sales over the product life cycle. Several major projects are expected to enter their launch phases and be revenue generating from 2016 and 2017.

Valuation: Strong growth expectations and rating

Stratec is a long-term strategic investment with a strong core business in mainstream diagnostics and a developing presence in the potentially very fast-growing molecular diagnostics area. It offers a way to invest in the advanced diagnostic sector. A move into liquid biopsy might give it a leading position in a new diagnostics space, where many of its existing clients have no current products.

Management guidance of an 8-12% CAGR over 2013-17 implies 2017 revenues of between €174m and €201m. The bulk of the growth from 2016 must come from new system launches, now underway, developing growth from recently launched products and from a rise in development project activities; this will also increase headcount and costs. The valuation methodology uses the discounted operational cash flow forecast less possible investment in intangible assets (about €6m per year) and then calculates a terminal value based on a 2017 forecast EPS (including options). On our revised EBIT expectations, the current share price implies a prospective 2017 P/E of 18x. Stratec has generally traded at its historic P/E of about 24x during 2015. A major strategic acquisition might put pressure on dividend levels and this could reduce their value but the shares are tightly held and illiquid.

Exhibit 2: Stratec indicative value

Value component

NPV/share (€)

Notes

Cash flow 2015-17

5.22

Operational cash flow minus investment in client development projects.

Continuing 2017 value

58.98

Assumes tax rate of 22% an EBIT margin of 19% and a P/E of 24x. Per share value includes 0.27m options.

Total value share per share

64.20

Discount rate of 10% as estimated as WACC by Stratec (annual report).

Indicative value

€767m

Based on 2017 value discounted to 2015.

Source: Edison Investment Research

Financial forecasts

We have adjusted the financial forecasts in Exhibit 3 in light of 2014 and Q315 financial reports and updated management guidance. In 2015, Stratec management projects a “slight increase” in revenues which means 1-3% growth using standard German definitions. The revenue increase to Q3 was 1.8%, but could rise further in Q4. Cash flow from operations and after investment to 30 Sept 2015 was €16.1m. Dividends in Q215 (€0.70/share) cost €8.2m, leaving a Q3 ytd cash gain of €7.4m. After €0.7m of currency effects, cash at 30 September 2015 was €54.7m up from €48.6m on 31 December 2014.

EBIT margin ytd was 17.9% and is guided by management to exceed this for FY15. We forecast 18% (€26.7m), Q3 EBIT margin was 19.5%. This implies strong service part sales in Q4 (we forecast €34.5m for FY15 vs €33.8m in FY14) with lower development recognition (we forecast €12.5m vs €14.6m in FY14). The tax rate used is 21% rising to 22% by 2017.

The 2016 forecast shows a significant rise in sales to more than €160m and EBIT margin of 18.5% implying €30.6m. EBIT is especially sensitive to service part sales levels, which are hard to forecast but recently appear to have been more consistent.

Exhibit 3: Financial summary

€000's

2013

2014

2015e

2016e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

 

 

 

 

Revenue

127,950

144,860

148,389

165,228

Cost of Sales

(86,186)

(99,924)

(94,354)

(107,189)

Gross Profit

41,764

44,936

54,034

58,039

EBITDA

28,031

31,130

34,239

38,103

Operating Profit (before amort. and except.)

25,469

29,656

32,739

36,603

Intangible Amortisation

(4,006)

(6,036)

(6,000)

(6,000)

Exceptionals

(935)

(624)

0

0

Other

(1,035)

1,056

0

0

EBIT (operating profit)

19,493

24,052

26,739

30,603

EBIT %

15.2%

16.6%

18.0%

18.5%

Net Interest

(160)

2

(157)

(157)

Profit Before Tax (norm)

25,309

29,658

32,582

36,446

Profit Before Tax (FRS 3)

19,333

24,054

26,582

30,446

Tax

(3,855)

(4,287)

(5,582)

(6,698)

Profit After Tax (norm)

21,454

25,371

27,000

29,748

Profit After Tax (FRS 3)

15,478

19,767

21,000

23,748

 

 

 

 

 

Average Number of Shares Outstanding (m)

11.7

11.8

11.8

11.8

EPS - normalised (c)

182.6

215.6

229.4

252.1

EPS - (IFRS) (c)

131.8

167.9

178.4

201.3

Dividend per share (c)

60.00

70.00

70.00

70.00

 

 

 

 

 

Gross Margin (%)

33%

31%

36%

35%

EBITDA Margin (%)

22%

21%

23%

23%

Operating Margin (before GW and except.) (%)

20%

20%

22%

22%

 

 

 

 

 

BALANCE SHEET

 

 

 

 

Fixed Assets

48,460

47,739

47,739

47,739

Intangible Assets

30,188

30,262

30,262

30,262

Tangible Assets

17,013

15,954

15,954

15,954

Investments

1,259

1,523

1,523

1,523

Current Assets

69,328

90,009

102,349

117,437

Stocks

18,091

18,066

17,800

18,250

Debtors

29,857

24,430

19,000

19,000

Cash

20,734

46,636

55,851

69,489

Other (inc ongoing services)

646

877

9,698

10,698

Current Liabilities

(12,564)

(15,586)

(15,585)

(15,585)

Creditors

(10,669)

(13,137)

(13,136)

(13,136)

Short term borrowings

(1,895)

(2,449)

(2,449)

(2,449)

Long Term Liabilities

(8,045)

(10,110)

(9,109)

(8,109)

Long term borrowings

(6,643)

(4,483)

(3,483)

(2,483)

Other long term liabilities (tax)

(1,402)

(5,627)

(5,626)

(5,626)

Net Assets

97,179

112,052

125,394

141,482

 

 

 

 

 

CASH FLOW

 

 

 

 

Operating Cash Flow

27,253

38,789

31,107

36,646

Net Interest

(138)

(36)

(150)

(150)

Tax

(3,278)

999

(5,582)

(6,698)

Capex

(2,575)

(1,474)

(1,500)

(1,500)

Intangible investment*

(7,518)

(5,215)

(6,000)

(6,000)

Acquisitions/disposals

(126)

176

0

0

Financing

662

(1,263)

(400)

(400)

Dividends

(6,566)

(7,055)

(8,260)

(8,260)

Net Cash Flow

7,714

24,921

9,215

13,638

Opening net debt/(cash)

(4,567)

(12,196)

(39,704)

(49,919)

HP finance leases initiated

0

0

0

0

Other

(85)

2,587

1,000

1,000

Closing net debt/(cash)

(12,196)

(39,704)

(49,919)

(64,557)

Source: Stratec accounts, Edison Investment Research Forecasts. Note:*R&D capitalised on unfunded development co-operations with construction contracts.

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