Mention China and most investors immediately think of commodities, yet to me healthcare is the more compelling story. China accounts for 20% of the world’s population, but only 1.5% of its drug sales. Its one-child policy will result in a disproportionate number of elderly people in the population by 2030, who will typically make use of up to five times more healthcare services than younger people. In response, Beijing is broadening medical insurance to cover 90% of its citizens and is training thousands of new doctors and building hundreds of hospitals.
That’s why the $25bn domestic pharmaceutical market is expanding at twice the rate of GDP and is set to hit $80bn by 2013 and $220bn in 2020. That’s marvellous news for the likes of Bayer, Germany’s largest drug-maker (and number-two player behind Pfizer in China), with local revenues of €530m in 2009 – up 28%.
Bayer’s low-dose aspirin for cardiac health is one of China’s biggest-selling drugs, alongside diabetes medicine Glucobay, and high-blood-pressure treatment Adalat. Better still, the firm plans to roll out 20 new compounds over the next five years, compared to three in 2009. These will come from its extensive portfolio of therapies in birth control, hormone replacement, multiple sclerosis, oncology and diagnostic imaging. One of the most promising is its recently approved oral contraceptive, Natazia, that produces far fewer side-effects than existing products.
Bayer AG (Xetra Dax: BAYN), tipped as a BUY by Merrill Lynch
So strategically important is the Chinese market that, despite concerns over intellectual property, Bayer even established a global research and development centre in Beijing last year and aims to invest another €100m by 2014.
And that’s not all. Although healthcare contributes around two-thirds of the group’s profits, Bayer is also a world leader in pesticides and environmental bioscience, and a top-three producer of advanced plastics. Sure, these divisions are cyclical, but with Asian demand rebounding they are also back on track. In fact, this recovery was confirmed in the third quarter of this year, with the board posting better-than-expected numbers and lifting its 2010 guidance for earnings before interest, tax, depreciation and amortisation (Ebitda) to €7bn and earnings-per-share growth to 15%. With the euro sinking, it’s likely further upgrades will occur owing to favourable foreign-exchange movements.
The City expects 2010 turnover and underlying earnings per share of €33.2bn and €4.0, rising to €34.6bn and €4.48 in 2011. This puts the stock on undemanding price/earnings (p/e) ratios of 11.8 and 10.5, while offering a 2.5% dividend yield.
However, I rate the pharma and non-healthcare divisions on ten and eight times Ebitda multiples respectively. After deducting net debt of €9.7bn and the €6.9bn pension deficit, that generates an intrinsic value of €58.50 per share.
So far so good, but what to watch out for? Bayer is affected by the usual headaches in the drug industry, including tighter government spending, patent expiries/challenges, pipeline setbacks and tougher regulatory approvals. Nonetheless, with its enormous research base and excellent emerging-market weighting, Bayer looks well placed to benefit from the long-term trends of ageing populations and improved lifestyles. There is even an outside chance that the firm could be taken over by a much bigger rival, or broken up, as happened to ICI in 1993 after it was stalked by Hanson Industries. Merrill Lynch has a price target of €68 per share.
Recommendation: BUY at €47.00
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments