chr. Hansen: Great company, but wait for a better entry point (CHYHY)
chr. Hansen (OTCPK:CHYHY) is a Danish company that few investors know about, and that’s a shame because it’s one of the strongest companies we know. It works with a significant competition, its revenues are very stable, as well as its pricing power and profit margins. It has growth opportunities in some of its markets, and overall it’s an extremely well-run business. The worst that can be said of Chr. Hansen is that the valuation is rather high and that we recommend waiting for a better entry point before buying stocks.
The company operated in three segments, but has since divested the natural color division. The remaining two segments are Food Cultures & Enzymes and Health & Nutrition. Food Cultures and Enzymes is the larger of the two and accounts for approximately two-thirds of sales. As the name suggests, this segment specializes in enzymes and microbes used for the production of things like cheese, yogurt. The Health and Nutrition segment specializes in microbes that have beneficial effects on the health of humans, plants and animals.
What makes Chr. Hansen is distinguished by the fact that it has more than 145 years of experience in optimizing these microbes for the various applications, that it has cost leadership thanks to its size, that it maintains close relationships with many clients and that it has a strong corporate culture focused on performance and attention to ESG practices. Indeed, more than 80% of its income contributes to the United Nations Sustainable Development Goals.
chr. Hansen has grown its revenue an average of 8.3% per year over the past few years, and for the past twelve months it has reached $1.34 billion. Revenues fell during the Covid crisis but have since recovered. For comparison, the company’s market capitalization is around $10 billion, so the sales multiple is high.
Profit margins reflect the strong pricing power of the company, and we can see how they have remained stable and high for years. Do not pay too much attention to the operating margin spike since it is due to non-recurring items. One thing to note is that despite inflation, supply chain issues, etc., gross profit margins remain above their average and at a very stable level. That’s the beauty of a company with the pricing power of Chr. Hansen.
Wide competitive moat
So why Chr. Does Hansen have such pricing power? It gets it from its strong competitive position which has multiple sources. It includes the extensive intellectual property that the company has tied to the manufacture and application of the various microbes. This intellectual property includes a large number of patents, trade secrets and strong brands. It also comes from the scale with which the business operates, and which new entrants to the business would struggle to replicate. Then there are the high switching costs that customers would incur if they switched providers. Since these microbes must be very specifically matched to an application, there is a significant risk that performance will change if customers change vendors. And since these ingredients represent a small percentage of the total value of the products produced, it is unlikely that a customer will switch suppliers due to a small price discount.
In the Food Cultures & Enzymes segment, the two main end markets are Fresh Dairy Products and Cheese. These are low growth markets with CAGRs of around 1-3%, nothing too exciting. The company has the opportunity to grow a bit faster by increasing its penetration rate, but don’t expect exciting growth from this business segment. Health and nutrition has many applications that are increasing at much more attractive CAGRs, such as plant health increasing by 15-18% and HMOs (prebiotics for infant formula) at over 20%. The opportunity to increase penetration in these markets is also greater with respect to food cultures and enzymes.
The company likes to use the term “lighthouses” to refer to opportunities that can be found by seeing farther afield. Some of these additional opportunities that the company believes can increase growth include bioprotection to help reduce food spoilage and increase food safety, alternatives to fermented milk and other fermented beverages, microbial crop protection for more sustainable agriculture, biotherapy and prebiotics for infant formula. All of these opportunities are expected to grow faster than the rest of the business.
The company has just over $1 billion in debt, which has been used to fund some of the recent acquisitions.
We don’t see this as a big deal given that debt to EBITDA remains reasonable at around 4x, but hopefully the company won’t stretch the balance sheet much further.
Given the company’s strong profitability and still reasonable leverage, Altman’s Z-score remains well above 3.0, meaning the company’s short-term risk of bankruptcy is negligible.
Where we have a problem with Chr. Hansen is when it comes to the valuation at which the company is trading. It has excellent profit margins, but it only has revenues slightly over a billion, and yet it trades with a market capitalization of nearly ten billion.
Free cash flow for the 2020/21 financial year was 196 million euros, which means that investors are paying around 50 times the free cash flow for the company, which we clearly think is too much raised. And this level of free cash flow is expected to decline in the 2021/22 financial year to a range of 140 to 170 million euros. This is too little, even if most of this cash flow returns to investors in the form of dividends.
Looking at EV/EBITDA, we get the same overvalued picture, with an EV/EBITDA ratio of ~32x. This is well below the peak reached of 48x, but still too high. We would be buyers if this valuation ratio fell further to the low of 20.
The company pays a dividend, but it’s not very regular. The reason for this is that there are years in which the company pays an ordinary dividend and an extraordinary dividend (paying out most of the profits of the company) and other years it only pays an ordinary dividend. This has the effect of making the dividend yield very variable, even with stable prices, as can be seen below. The corresponding dividend yield can be seen to the right of the chart.
According to Corporate Knights, Chr. Hansen is the second most sustainable company in the world. The company has estimated that over a billion people consume a product with a Chr. Hansen ingredients every day, and that 82% of its turnover contributes positively to one of the United Nations Sustainable Development Goals.
The company helps the dairy and agricultural industries become more efficient with solutions that improve productivity and generally do more with less. The company also has several long-term sustainability goals such as 200 million people consuming its probiotics, 2 million tonnes of yoghurt waste reduced, 100% renewable electricity usage, 100% key packaging materials recyclables, a 1:1 ratio of female employees and women. in management, among others.
chr. Hansen is a remarkable company with significant pricing power, which should help in an inflationary environment. As well as very strong competitive moats from multiple sources including IP and high switching costs. The company has several exciting opportunities in new markets and applications, and that should keep growth at a decent pace. chr. Hansen is considered a leader in sustainability through its products as well as its corporate sustainability practices. There’s a lot to like about the company, and we think it’s a really exceptional company, we’re just a bit concerned about the valuation and will wait until the price is a bit cheaper before investing.