Analysis of BioGaia, 2017

BioGaia is a Swedish company, headquartered in Stockholm and listed on the Stockholm Stock Exchange, which is active in the probiotics market of bioscience. It owns the rights to sell and market two well-researched strains of the bacteria Lactobacillus reuteri, which has proven to be efficient for disorders such as colic and constipation. In some niched segments of probiotics, the company is a world leader. BioGaia has a solid growth and an exceptional return on assets, but it’s expensive at a P/E of 33. The question is if the prospects of the company outweighs this high price. Keep reading (or skip to the end) to get the answer today!

Products

BioGaia is a bioscience company, developing, marketing and selling products within the probiotics segment of health products. Its products are based on two strains called Lactobacillus reuteri Protectis and Lactobacillus reuteri Prodentis, which have well-documented efficiency in colic, gut health and oral health. The products come in many different forms – including drops, straws, tablets and powder.

BioGaia divides the products into three categories:

  • Children’s health: The largest segment. During 2016, the revenue from this segment was SEK 433 million (USD 52 million). Here, multiple products for infants are being developed, marketed and sold, including drops (the most popular product), tablets for gut health, replacements for mother’s milk and milk powder.
  • Adult’s health: Revenue of SEK 85 million (USD 10 million) in 2016. Includes products such as gut health tables and oral health tablets.
  • Other: Revenue of SEK 16 million (USD 1,9 million). Almost all the income comes from a deal with Nestlé.

In most countries, the products are labeled food supplements, but in some markets, such as Turkey, Hongkong and Peru, they are categorized as medicine.

The most popular product is the drops for children’s health. It is marketed as, and has several studies showing that, it can help reducing the symptoms from a condition called colic among infants. Colic is excessive crying, unrelated to any known medical problem, which is estimated to be the cause of one in five visits to pediatricians. Furthermore, it’s a source of anxiety for parents.

The company itself choses to put the benefits of its probiotic in the following way:

“Just like a polite and friendly friend, Lactobacillius reuteri maintains the conversation between host and bacteria, without invading the host or dominate among the bacteria. Lacotbacillius reuteri is therefore no bully, but a great neighbor.”

The conditions that the products have been proven in clinical studies to be helpful for are:

  • Bloating: Abnormal gas swelling of the gastrointestinal tract. Makes you feel “fluffy”.
  • Colic: Excessive crying unrelated to any known medical problem
  • Constipation: Infrequent and hard to pass toilet visits
  • Diarrhea: Well … Opposite of constipation
  • Pylori: A bacteria that causes chronic inflammation in the stomach
  • Oral health: Gum health and reduction of tooth decay

Outside of its core businesses, BioGaia is researching if certain tribes of Lacotobacillius reuteri can prevent and/or reduce IBD – Inflammatory bowel disease. The most common diseases here are Crohn’s disease and Ulcerative colitis, which in many cases causes lifelong treatments with medicine (approximately USD 8 billion yearly market). Furthermore, BioGaia owns 36% of a company called MetaboGen, which is doing research in an area called microbiome – the science of all the microorganisms in a specific area (for instance, the large intestine). This is a small part of the business today, but it’s a hot research topic, and might be significant in the future.

Geographies

Today the products of BioGaia are being sold in approximately 90 countries. The offices are located in Sweden, USA and Japan, and are meant to support distributors in nearby geographies to penetrate the markets.  Another office will be opened in 2018, in Singapore. Markets with strong presence today are Italy, Spain, France, Germany and Turkey. China is mentioned as a very interesting market in the future, but the regulatory system there is complex, and it takes several years before registration and marketing of products are possible.

A two-digit growth can be seen in all markets except for “Rest of world”. Brazil, which is the most important country in this segment, had high inventory levels at the end of 2015 because of massive purchases during the year. According to the CEO, these levels are now back to normal.

Business model

The business model consists of three networks – development, production and distribution. For development, the company has partnerships with more than 50 institutes around the world. Products are manufactured in six different sites in the US and in Europe. BioGaia also produces in its own regime, in the subsidiary called TwoPac, but this is primarily packaging for not the actual probiotics. Distribution is handled by more than 60 partners, among others, Nestlé and Abbott. The distribution network is well-established in children’s health but is “under construction” for adult’s health.

A strong focus lies on promoting products for doctors and pharmacy staff, which later recommends them to their patients.

BioGaia has shifted focus, and is now trying to sell as many of its current products under the brand name BioGaia as possible. This has proven to be the most efficient brand to use among customers, and the company wants to use it for synergies. A new design on all its packaging is now being implemented and the goal is to be done by 2018.

Recently, the company has announced that it will change its EBIT-margin target, from 30% to 34%. This is a sign of strength. At the same time, it has reported that margins for gut health and oral health tablets are shrinking due to higher costs for bacterial culture. Some scalability should exist in the business model, but it’s hard to tell from the graph. For every extra product sold, an additional product must be manufactured and distributed, although costs for R&D are quite high and could be shared among products.

Customers

One buying criterion is what the local doctor recommends. Apparently, the largest customer segment is mothers, both for buying products for their kids, but also for buying probiotic supplements for themselves.

The company identifies itself as more of a B2B company than a B2C, because its key stakeholders are doctors and the distributors, rather than everyday-people. Therefore, it’s of high importance to prove the products in clinical trials, for the doctors to recommend products. BioGaia does have a strong network of distributors, marketing the products in over 90 different countries to affect this.

Employees

Average sickness leave of 1,7%, compared to 3,5% per year for the overall Swedish figure. Turnover at the company is about 14%, compared to 20% per year for the overall. The salary is also above the Swedish average for its benchmark segment, and therefore I think it’s fair to say that BioGaia is a good employer.

Executives

The company was founded in 1990 by Peter Rothschild and Jan Annwall. Both of them still works at the company. Peter Rothschild is the group executive (strategic role), while Jan Annwall is in the executive board and works partly as a consultant for the company. They still own quite a large stake in the company, although I think that the total ownership across the group executives and the board members (10%) is a bit low. No change in insider ownership has occurred since mid-2015.

BioGaia recently hired a new CEO, since the last one wanted to have more of a strategic than an operational role. The new CEO has a relevant background in the industry, with prior roles at Gambro and Getinge (just like CellaVision’s new CEO, a company I’ve analyzed before). Salary levels among the group executives and the CEO are reasonable, neither high or low. Furthermore, the company is good at internal recruitment, a lot of people get promotions from within the firm.

Valuation + Key financials

BioGaia has experienced rapid growth since 2012 (at least when excluding a one-time order from Nestlé). ROA at 35% is exceptional, one of the highest that I’ve heard of. Furthermore, the financials are great, according to all major KPIs. Especially the Debt/Equity-ratio is impressive. The company has a defensive financing structure, and can afford debt-driven expansion without any problems. Maybe to start its own fermentation (manufacturing of probiotics) process later down the road?

As expected, this growth is clearly showing in the valuation of BioGaia. According to all multiples, the company is expensive at the moment. At the same time, it has a generous dividend-policy, usually more than 2/3 of the profit becomes dividends. These two situations in combination is something I strongly dislike. With a ROA at 35%, why not reinvest money in the business? Maybe there aren’t that many opportunities out there.

R&D makes up a sizeable proportion of the revenue, which is a good thing. During 2016, its share was 12%, which is 20% higher than one year before. These expenses are accounted for before dividends are payed, and therefore the actual reinvestment in the business is higher than the profit/dividend-ratio indicates.

Market

The positive role that bacteria can play in humans was first introduced by a Russian scientist named Élie Matchnikoff, in 1907. He suggested that it was possible to replace harmful microbes with useful ones by manipulating the gut flora. What he didn’t realize was that it would take almost another 100 years before his idea would become a commercial success, in the form of probiotics.

Probiotics in general is expected to grow by 7% per year until 2023. The size of the market was estimated to USD 35 billion in 2015, where functional food and beverages, a segment where BioGaia doesn’t have a strong presence yet, makes up 80%. The company’s share of the total market is therefore microscopic today, which can be both positive and negative.

There seems to be an optimistic outlook from the EFSA (European food and safety authority) and the FDA (US food and drug administration) regarding probiotics, which is expected to have a positive impact on the industry growth. Other drivers are increase in disposable income and rising living standards, especially in the Asia Pacific.

Different geographies are anticipated to develop in separate ways. In Asia, the large markets of India and China are expected to consume more infant formulas, something that can benefit BioGaia. Another aspect worth mentioning is that Brazil, which is a key geography for the company, is though to have an extremely rapid development, by as much as 50% per year.

Competitive landscape

The competitive landscape of probiotics is fragmented – the five industry leaders together made up 40% of the global market in 2015. Top three in the world are Chr. Hansen, DuPont/Danisco and Lallemand. These three makes up around 70% of all the fermentation) of probiotics in the world, which means that they control an important part of the value chain. The fermentation process requires large volumes for it to be profitable, so only the largest actors can do it efficiently.

The top competitors are:

  • Hansen, with the strains Bifidobacterium lactis BB-12, Lactobaciullus acidophilus LA-05 and Lactobaciullus rhamnosus GG (LGG)
  • DuPont/Danisco, with the strains Bifidobacterium lactis Bi-07 and Lactobacillus acidophilus NCFM
  • Lallemand, with the strains Lactobacillus acidophilus Rosell-52, Lactobacillus rhamnosus Rosell-11 and Saccharomyces cerevisae boulardii
  • Yakult, with the strain Lactobacillus casei Shirota

Chr. Hansen

This company is a global bioscience one, active in more than 32 countries worldwide, originally from Denmark. It has more than 3000 employees and a yearly turnover of around EUR 1 billion. It’s therefore about 20 times as big as BioGaia, but all the revenue doesn’t come from probiotics. It develops products for food, nutritional, agricultural and pharmaceutical industries.

In 2016, Chr. Hansen bought the rights for the bacterial strain Lactobacillus rhamnosus GG, the world’s most researched one, for EUR 73 million. This strain has about 300 clinical trials supporting it, compared to BioGaia’s Protectis which has about 120.  Chr. Hansen is the owner of about 30 000 strains, where Bifidobacterium lactis BB-12, Lactobaciullus acidophilus LA-05 and Lactobaciullus rhamnosus GG are the most researched ones competing with BioGaia.

Chr. Hansen is one of the few companies in the world of probiotics being large enough to have its own fermentation process. Therefore, it earns money from producing strains for other companies. It also earns money from royalties from other companies selling its patented strains.

DuPont/Danisco

DuPont is a massive conglomerate of different businesses, including, among others, electronics, agriculture, industrial bioscience and nutrition and health (BioGaia’s segment). Nutrition and health had more than USD 3 billion in revenue worldwide in 2016. According to the company itself, it offers the widest range of probiotics that are stable and have clinical documentation in the world.

DuPont bought the Danish food company Danisco in 2011, and increased its revenues in the Nutrition & Health segment by about a billion USD. Today it’s the owner of two strains that are competitors to BioGaia, Bifidobacterium lactis Bi-07 and Lactobacillus acidophilus NCFM. DuPont offers two solutions – HOWARU, preblended probiotics, and FloraFit, which is several patented strains, available for customized blend. Primarily it’s B2B solutions, where other companies market and sells the products to the end-customers.

Lallemand

Canadian competitor with about 3000 employees. This company researches, produces, develops and markets yeast and bacteria products. Like Chr. Hansen and DuPont, it’s a one-stop shop for probiotics, providing both ready-to-market solutions and a flexible combination of patented probiotics.

The company’s most important strains (for a potential BioGaia-investor) are Lactobacillus acidophilus Rosell-52, Lactobacillus rhamnosus Rosell-11 and Saccharomyces cerevisae boulardii.

Yakult

Yakult is primarily a producer and supplier of a fermented milk product with the same name. It has a revenue of around JPY 380 billion (USD 3,3 billion), with about 50% of the revenue coming from Japan, and 25% coming from the rest of Asia and Oceania.

The company holds a patent for Lactobacillus casei Shirota, which is the strain with most similar (clinically proven) benefits as BioGaia’s strains.

BioGaia is the only company with a patented strain for colic in infants. It’s also the only company with a strain, except for Shirota, that has proven benefits for oral health (at least extensive ones). This makes the company a top 2 in 2/3 of its markets, and probably (educated guess) around 70% of its revenue. For gut health, there are several other competitors, and I think it’s fair to say that BioGaia is above average, but not in the absolute top.

Geographic-wise, BioGaia doesn’t have the same presence as some of its competitors. This means that it’s more difficult for the company to penetrate local markets, as influencing doctors and pharmacists becomes harder.

When it comes to innovation, I think non of the companies researched are doing a lot. In this industry, developing and clinically reinforcing a product takes a long time though, so it might be understandable. BioGaia seems to be doing as well as, or better than, the other industry leaders when it comes to geographical expansion and new research supporting the products, which is another sign of strength.

Altogether, BioGaia is a top performer in the probiotics market, and should be able to achiev a higher growth than the 7% that the market is expected to grow with on average, especially for its colic and oral health segements.

For the treatment of colic in a baby, there are several competing options outside of the probiotics market as well:

  • Simethicone: Makes it easier for the baby to burp out air swallowed while fed, therefore it is supposed to reduce bowl discomfort. Several studies have shown that the medicine doesn’t work better than placebo though, and the reason is argued to be that trapped gas isn’t the cause for the colic in the first place. Some studies have been made, comparing simethicone versus Lacotbacillius reuteri, and they have shown that Lacotbacillius reuteri has a better effect.
  • Herbal remedies: Herbs are provided for several reasons – among others – to improve digestion, reduce inflammation, calm and/or lessen gas production. One study has shown that a combination of Matricaria chamomilla (herb), Melissa officinalis (herb) and Lacotbacilliusacidophilus (probiotic) is even more efficient in the treatment of colic than Lacotbacillius reuteri, but from what I can see, there are no such products in the market yet. Also, this is the result of just one study.
  • Tranquilizers/Sedatives: Medicine to calm the baby down. This works quite well but has the downside that the baby gets dizzy, and it’s just a temporary fix.
  • Antihistamines: If the reason for the crying can be expected to occur due to allergies, this medicine can be effective. This is not directly competing with BioGaia since it doesn’t cure the same symptoms, BioGaia is curing colic caused by problems in the intestines, not related to allergies.

Conclusion: BioGaia’s products are among the best to treat colic, even considering medication outside of the probiotic market. There’s still quite a big market for simethicone, but I think that gradually this will be replaced by, for instance, probiotics.

Moat

The strains that BioGaia owns have patents expiring in 2027 and 2028. They are the best in the industry when it comes to treatment of colic and oral health, and it takes quite a while to develop new products. BioGaia has a great advantage in that it early on treated its probiotics like pharmacies treat drugs, with solid clinical trials to back them up.

BioGaia also has the best packaging of its products. Drops are well-suited for babies because they are easy to swallow and can be mixed with infant formula or mother’s milk. Some of these packaging are patented as well.

Risks

50% of the company’s revenues are in euros while 50% of the costs are in SEK. Therefore, the profit may be affected by a strengthening/weakening of the euro, but primarily in the short run.

BioGaia is dependent on a few suppliers to produce its probiotics. From what I can see, the number of them, or the specific names, are not mentioned. What we can know though, is that it should only be a few, because three of the companies – Chr. Hansen, DuPont and Lallemand – produces 70% of all the probiotics in the world. These relations are very important to maintain, but it’s complicated as they are competitors at the same time. The contracts are 3-7 years long as a standard though, which reduces the risk.

There’s always a risk that another company develops a better product than BioGaia, but in this industry, development and establishment of a product takes time. And from what I can tell, there’s only one such threat right now, and that’s the combination of Matricaria chamomilla, Melissa officinalis and Lacotbacillius acidophilus that was proven better than Lacotbacillius reuteri for colic in one study.

DCF

The target for the operating margin was recently increased by the company from 30% to 34%, despite the fermentation process becoming more and more expensive. The release of EasyDropper might have a chance to increase the revenue growth slightly compared to previous years and then there’s also the recent establishment of a subsidiary for developing probiotic medical drugs. A lottery-ticket included in an investment in BioGaia is the 36% ownership in MetaboGen. Altogether, a lot of exciting things are happening in the company right now.

As usual, with companies such as BioGaia, price is where the shoe pinches. On the result for the last twelve months, the company is trading at a P/E of 33. The historical growth of revenue has been slightly above 11%, and the market is growing by 7%. BioGaia might be able to grow more rapidly than that in the coming years, but not as much as needed if it should yield 15%+.

For BioGaia to yield this much, something like this must happen:

  • One of the large players decides to buy the company. What should be considered here though is that in 2016, Chr. Hansen bought the most well-researched strain, LGG, for EUR 73 million. BioGaia’s current value is almost ten times that.
  • An abnormal revenue growth is achieved, up towards 30% for a couple of years to come. Maybe through a breakthrough in either MetaboGen or the recently established subsidiary, for instance in the IBD market.
  • The profit margin is increased in combination with a high growth at around 20%, perhaps by BioGaia successfully starting its own fermentation of probiotics, increasing margins and giving new business opportunities

To me, these are unlikely events. Therefore, I give the company two out of five igloos.

What do you think about BioGaia? Is Lacotobacillius reuteri going to be the cure for IBD and the likes in the future, and therefore the company is undervalued? Let us know in a comment!

For more investment tips, based on more than a gut feeling, stay tuned!

NOTE: I do not own shares in BioGaia

This entry was posted in Investments. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *