Bayer can claim the title of the most valuable German industrial corporation since August of last year.
The chemical and pharmaceutical giant won an additional €9 billion, or $9.8 billion, in market capitalization in 2014, and another €20 billion since the beginning of 2015. Currently, it is worth about €114 billion.
The company’s shareholders have little reason to complain when they meet on Wednesday at the Bayer annual general meeting. It appears as if the Bayer chief executive, Marijn Dekkers, is doing almost everything right, from the research and marketing strategy in the pharmaceutical business up to the planned spin-off of the plastics division, Bayer Material Science.
Mr. Dekkers waived more margins to force growth – a strategy that is exceptionally well-received on the capital market.
Mr. Dekkers, a 57-year old chemist who was voted “manager of the year” by Germany’s Manager Magazin in 2014, has said his job is not done yet but he has already announced he wants to retire at the end of next year.
At the annual general shareholders meeting on Wednesday, he will confirm the company’s upward trend but it does not serve as definitive proof of the Leverkusen-based corporation’s top position. In absolute earnings power Bayer only ranks sixth or seventh in Germany.
Germany’s automobile companies, chemicals maker BASF and engineering firm Siemens showed considerably higher operating and net profits for 2014, and companies such as software maker SAP and pharmaceutical firm Merck KGaA achieved better yields.
In addition, as with almost all companies currently, one could say that for Bayer the recent stock price gains have run ahead of the realized earnings.
It is true, the numbers are impressive. After all, earnings before interest and tax rose by almost 12 percent to €5.5 billion, and net profit rose by a good 7 percent to €3.4 billion.
Substantial factors behind the rise in profits were lower expenditures for restructuring, valuation allowances and legal risks. These negative “special influences” dropped by half for the second year in a row.
The difference between the reported earnings before interest and tax and the one excluding special items was, at €438 million, lower than it has been in 10 years.
That indicates that the operating profit performance in 2014 was recently weaker than the official conclusion suggests. The adjusted operating profit, excluding special items, only rose by 3 percent.
The company’s plastics subsidiary, Bayer Material Science, posted disproportionate gains, after falling to a very low level the year before. Bayer posted only a 2 percent increase in adjusted operating profit for its plant protection and seeds divisions, CropScience.
In the consumer health division there was a two-digit decline due to revenue shortfalls in diabetes testing devices and medical care and contrast agents.
There was also clearly a very aggressive push made in marketing. Sales and marketing costs recently rose slightly disproportionately to €11 billion, which corresponds to a 26 percent share of sales.
As such, Bayer is moving into a level above many purely pharmaceutical and health corporations. Novartis, for example, has sales and marketing costs at about 24 percent of total revenue.
At Bayer, about half of the sales come from the chemical business, which is much less marketing intensive. If one assumes a marketing cost rate of about 14 percent, which is common for the sector, for the chemicals operations Bayer CropScience and Bayer MaterialScience, then about €8 billion of the €11 billion sales and marketing costs of Bayer fall into the health-care divisions.
Even if one deducts the included licensing and commissions expenses of about €1 billion, Bayer’s healthcare operations still faces an above-average sales and marketing cost rate of almost 35 percent of sales.
In comparison, for the top 10 in the pharmaceutical industry, on average the share of administrative and sales costs together are almost 30 percent.
This discrepancy explains why Bayer’s healthcare operations overall and the well-performing pharmaceutical division in particular, as before, have an operating margin 4 to 5 percentage points lower than that of rivals. The adjusted earnings before interest, tax, depreciation and amortization margins have practically not improved at all over the past five years.
That means the corporation could hardly retrieve economies of scale so far from its successes in pharmaceutical research and the expansion of the healthcare business. It bought its growth in effect with a disproportionate rise in sales expenses.
Or, put differently, Mr. Dekkers waived more margins to force growth – a strategy that is exceptionally well-received on the capital market.
In yet another respect Bayer clearly forced investment in growth in recent years. Its expenditures in machines and equipment increased by about half since 2010, and its rate of investment in relation to sales rose from 4.3 to 5.6 percent.
In addition, in the past two years Bayer became considerably more active in acquisitions, with purchases such as Steigerwald, Conceptus, Algeta, Dihon and especially recently with the €11.2 billion takeover of the division for over-the-counter drugs operations of U.S. rival Merck & Co.
The second-largest acquisition in the company’s history may bring in a good €1.5 billion in additional annual sales to the group and an estimated €300 to 400 million in earnings before interest, tax, depreciation and amortization. In order to recoup the high price for this deal, the group will have to invest.
There may initially be not just higher financial expenditures, but also integrating and marketing costs to develop the global potential for the over-the-counter products from Merck.
The division, which was included in the balance sheet in October, delivered €73 million in adjusted earnings before interest, tax, depreciation and amortization in 2014, but burdened overall net earnings with €108 million. The purchases of Algeta and Dihon caused a further €132 million drag on profits.
The string of purchases also left considerable effects in the balance sheet structure. Net financial debt tripled, despite strong cash flow, in one fell swoop to €19.6 billion. As a result of the phase of low interest rates, Bayer also had to increase pension provisions by about €5 billion.
Despite record profits, equity on the balance sheet fell slightly and the equity ratio, which compares equity to total assets, worsened from 40 to only about 28 percent, the lowest level in decades.
None of that prevented shareholders from valuing the corporation at almost six times its book value. Nevertheless, the company’s financial agility appears to have been restricted considerably, especially if one wants to secure the current investment grade rating.
Therefore it is obvious that the planned spin-off of the plastics business Bayer MaterialScience does not follow purely industrial logic. Mr. Dekkers can use the earnings from a possible initial public offering to gain financial flexibility for further expansion.
The next opportunities for expanding the healthcare and crop science businesses will come possibly sooner than expected.
Siegfried Hofmann is Handelsblatt’s chemical and pharmaceutical industries correspondent. To contact the author: firstname.lastname@example.org