Relatively their earning model is rather simple. They make money by selling products, i.e., GMO seeds, crop protection, Eye Disease drugs, OTC medications, Nutritional supplements, etc. More volume in sales transmutes directly to revenue. I can take this both positively and negatively. Positive in the sense that they should be able to predict future revenue relatively easily. But they would need some blockbuster drugs or chemicals for more optimistic growth than industry.
FY 2020, their revenue was € 41.4 billion. According to the annual report, Adverse currency effects cost the company € 1.9 Billion in revenue. I take this as part & parcel of being in business and would not assume that currency impact would be less in the coming years. Doing that, I can expect pleasant surprises in the future when the tide turns the other way.
The sharp increase in Crop science revenue in 2018 was due to the merger with Monsanto, for which Bayer shelled out 63 Billion euros.
Crop Science: The overall volume of sales increased, but currency impacted revenue. Sales increased in Asia and Latin America but decreased in Europe and North America. Litigation settlement cost them a fortune. 10 billion and counting. More on this a bit later.
Pharma: Volume increased, but price decreased because of price pressure from generic drugs. Currency impacted here as well. Litigation settlement for around 1.5 Billion Euros.
Consumer Health: Volume increased because of the sharp rise in demand to support the immune system, leading to growth in nutritional supplements, But Social distancing and hygiene declined the sales of cold and cough products. The prices of products increased as well.
According to the company, EBITDA before special items* (I didn’t know this category existed before I saw their balance sheet) remained unchanged because of their stringent cost management. It means they want to achieve growth in earnings with operational efficiency. If they succeed, I should see an impact on the balance sheet in the coming years.
According to Charlie Mungar and Warren Buffet, I can find more fraud in companies that report EBITDA than companies that don’t. So I need to proceed with caution.
I could find a couple of reasons why they would opt for EBITDA instead. In some cases, it does make sense, As some losses are due to litigation and may or may not roll over every year. For others, I am still trying to make sense. Observing operating expenses, it is clear that legal and impairment losses on goodwill contributed to losses.
Litigation: Both the primary division’s Crop Science and Pharma, are battling in the court. Bayer lost a lawsuit alleging that Monsanto’s Roundup herbicide causes cancer, and the payoff is going through the roof. Bayer merged with Monsanto in 2018 and for which it paid 63 Billion Euros. It was called the worst corporate deals (Source: WSJ). Whether it was the worst or not, the deal is done and dusted. The stock price plunged in the aftermath & rightly so.
Last year, Bayer/Monsanto reached an agreement to settle most of the current Roundup™ litigation without the admission of liability, involving most of the total approximately 125,000 then known filed and unfiled claims, and to put in place a mechanism to resolve potential future claims. The expected settlement cost of US$9.6 billion. Plaintiffs who opt out of a settlement have the right to pursue their claims separately against the company. In May this year, the company came up with 5 step plan (Source).
- Seek favorable ruling from the U.S. Supreme court. As recent as 5th Oct, Company reported that the jury in the Clark trial issued a verdict in their favor.
- The company set aside $4.5 billion to manage the anticipated claims.
- They settled ~96,000 of the ~125,000 current cases. They are prepared to defend at trial when the demands of hold-out plaintiff firms are unreasonable.
- To further reduce future litigation risk, they will replace glyphosate products in the U.S. with new formulations beginning 2023.
- Promote a new safety study webpage about glyphosate products.
Three more litigations include a 1.6 Billion dollar settlement for claims involving women who allege device-related injuries, 400 million dollars payout for damage to crops from drifting of dicamba & US$170 million concerning the effects of PCBs in bodies of water.
Bayer used more than 13 billion euros last year for these litigations. 4.5 Billion dollars more are kept aside this year for the future.
Impairment losses on goodwill: Before I dig this further, I need to understand what it means. The definition, according to Investopedia, “
“Goodwill impairment occurs when a company decides to pay more than book value for the acquisition of an asset, and then the value of that asset declines. The difference between the amount that the company paid for the asset and the book value of the asset is known as goodwill. The company has to adjust the book value of that goodwill down if it becomes impaired.”
The crop sciences division mainly contributed towards impairment losses.
Reduced growth expectations in the agricultural industry, particularly in North and Latin America, resulted in these impairments. A rise in the weighted average cost of capital and extreme currency effects negatively affected the company. Calculating it for the future is not impossible, but I need to keep the information in mind when evaluating.
Debt: One more area of concern with the company is Debt. It stands at more than ~40 billion euros as of Jun 2021. Last year company sold the Animal health division to Elanco and collected 8.7 billion dollars which they used to pay some of its liabilities.
Patents Expiration: Patents are essential to any pharma company. Longer the expiration date longer the stream of revenues. The expiration of patents of wonder drugs Eylea™ & Xarelto™ is very near. Even the company understands it and hence suggested the following slowdown in 2024. I am not as excited as Bayer is about growth post-2025, but any new drug in the pipeline may bridge the gap.
Now I know a bit about the company and the risks it carries. It’s time to build a story and conclude. Until then, do svidaniya.