The Fresenius stock – An underrated dividend aristocrat?

The Fresenius stock has taken quite a beating in recent years, having lost about half of its value since its all-time high in 2017. While the stock markets climbed to record highs, shareholders of Fresenius had to watch the value of their holdings melt away.

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As a result of the price drop, several key figures are now indicating that the stock might be undervalued. The stock has halved its P/E ratio and doubled its dividend yield. Furthermore, revenues and earnings are expected to increase in the coming years. This leads to the assumption that the sell-off might have been exaggerated. In this analysis you will find out whether the Fresenius stock is worth to buy right now.

Fresenius stock
Logo
Country	Germany
Industry	Healthcare
Isin	DE0005785604
Market cap.	26.0 billion $
Stock Price	47.01 USD
Dividend yield	2.1%
Dividend stability	0.95 of max. 1.0
Earnings stability	0.97 of max. 1.0

The business model: This is how Fresenius earns its money

Fresenius is a German health care company active in the fields of medical technology, pharmaceuticals, and health care services. It is also one of the largest hospital operators in Germany and employs more than 300,000 people in over 100 countries worldwide. Fresenius is best known for the treatment of renal diseases, which it offers through its subsidiary Fresenius Medical Care.

Subsidiaries of Fresenius (Source: Presentation)

Business segments of Fresenius

The business activity of Fresenius is divided into four legally independent companies. Two of these subsidiaries, Kabi and Helios, are wholly owned subsidiaries. Fresenius owns 32 percent of Fresenius Medical Care and 77 percent of Vamed.

Revenues of Fresenius by segment (Source: FactSet Workstation)

Fresenius Medical Care

Fresenius Medical Care (FMC) is the world’s leading provider of dialysis products treatments for renal diseases. Fresenius estimates the global dialysis market at about 80 billion euros (page 7), of which 17.5 billion euros are generated by Fresenius Medical Care, representing a market share of about 22 percent. Fresenius derives about half of its revenues from its ownership stake in FMC which is an essential part of Fresenius.

Fresenius Kabi

Fresenius Kabi offers intravenously administered drugs, clinical nutrition, and infusion therapies. This segment also produces medical devices and products for the treatment of cancer and autoimmune diseases. Kabi is only the third largest business segment in terms of revenue but it achieves the highest operating margin out of the four.

Fresenius Helios

Fresenius Helios is an operator of hospitals and other healthcare facilities. Helios primarily conducts its business in Germany, but it is also present in Spain and Latin America. In Germany, Helios operates 86 hospitals, as well as 125 outpatient treatment centers. Measured by revenues, Helios is Fresenius’ second largest segment after FMC.

Fresenius Vamed

Fresenius Vamed is a project manager and service provider for healthcare facilities. Vamed’s services cover the entire value chain from planning, through construction, to the operation of a facility. This segment is by far the smallest. Additionally, this subsidiary has hardly been profitable so far. However, Vamed is a growth driver for Fresenius, as its revenues are growing three times as fast as those of the other business segments (page 5).

Solid business model

Because of its strong focus on the treatment of chronic diseases, Fresenius’ business model is fairly crisis-proof and has also proven its resilience during the Covid-19 pandemic. A dialysis patient needs regular treatment, which cannot be suspended or postponed even during a pandemic. In addition, Fresenius is well diversified through its various segments. In the past quarter, Fresenius grew its revenues by five percent despite the pandemic headwinds (presentation: page 32).

Growth potential of Fresenius

Fresenius benefits from an aging population in which age-related diseases, such as renal diseases, are on the rise. Fresenius profits from this trend by supplying the products and services to treat such diseases. Another megatrend playing into Fresenius’ hands is the general economic growth of countries, as wealthier populations can afford better health care.

Growth potential of Fresenius (Source: presentation: page 11)

How profitable is Fresenius?

Fresenius has an impressive growth history. Over the past 10 years, revenues have increased by close to 9 percent on average per year. Revenues have been consistently going up without any setbacks. As you can see in the chart below, there has not been a single major drop in revenues in the last 20 years. However, growth has slowed in recent years. In addition, the operating margin has declined slightly. This effect is not unusual, as companies often need to invest in lower margin operations in order to grow revenues which drags down the average margin. This development is not an issue by any means. The operating margin remains at a solid double-digit level of 12.5 percent. Analyst forecasts are calling for increases in both the operating margin and revenues in the coming years. By the end of 2023, revenues are expected to rise from the current level of 36 billion euros to 42 billion euros and the operating margin is expected to increase by around one percentage point. Those assumptions are plausible in my opinion as I expect further grow potential for Fresenius once the headwinds from the Covid-19 pandemic subside.

Development of revenues and the operating margin of Fresenius

Those revenue increases led to growth in both profit and cash flow. Fresenius has grown its profits by 10 percent annually over the past decade. The reason for the profit decline in 2019 is a one-time effect in 2018 which extraordinarily raised the profit in that year. Since one-time effects do not re-occur, the profit in 2019 was lower.

2020 did not bring profit per share growth either. The Corona pandemic is negatively affecting two business segments of Fresenius. The Kabi subsidiary was negatively affected due to the postponement of elective surgeries and treatments. The project manager Vamed is also affected as projects were postponed during the pandemic. According to its own figures, Fresenius would have achieved sales growth of 7-8 percent in the last 3 quarters if the pandemic had not occurred (page 7).

Operating Cash Flow grew by an average of 14 percent annually in the last 10 years and reached an all-time high in 2020. The reasons for this upward spike are the government support included in the pandemic response measures of the USA and a reduction of payment targets in order to ease the burden on hospitals in Germany (page 9). However, these are one-time effects which means that cash flow will not stay this high. Compared with previous years, analysts nevertheless expect further growth in cash flow and earnings in the coming years. I also expect Fresenius to grow again as soon as the subsidiaries Kabi and Vamed are no longer burdened by Covid-19.

Development of profits, cash flows, dividends and payout ratio of Fresenius

Is the dividend of Fresenius safe?

As a result of its strong growth, Fresenius was able to generously increase its dividend. Just within the last 5 years  the dividend was raised by an average of close to 15 percent per year. Those increases were fully financed from profit gains as opposed to raising the payout ratio. As a matter of fact, the payout ratio has barely changed over the last decade. Had dividend increases not come from the growth in profit, we would have seen the payout ratio go up as well. Furthermore, the low payout ratio ensures that enough money remains in the company to finance new projects and acquisitions which in turn will fuel future growth. Its impressive dividend history makes Fresenius one of the dividend aristocrats which have increased their dividends for more than 25 consecutive years.

Fresenius SE Dividend History

As is common in Germany, Fresenius pays an annual dividend as opposed to quarterly payouts like companies do in the USA. Shareholders currently receive a payment of 1.03 dollars, which translates into a dividend yield of 2.09 percent. This yield does not strike anyone as particularly high at first glance. However, Fresenius only pays out a quarter of its earnings as a dividend. A payout ratio of a moderate 50 percent would already give Fresenius a dividend yield of more than 4 percent and would probably be perceived very differently by many investors. Since Fresenius invests most of its profits in new projects and acquisitions, you do not get a high dividend yield right away, but you do get revenue and earnings growth, which means the dividend will be higher in the future. The dividend history of the company shows how quickly this can turn a moderate yield into a high one. Since 2010, the dividend has almost tripled. This makes it easier to accept an initially lower yield. However, it has to be noted that the dividend growth has slowed in recent years. The reason for this is the company policy to only pay out 20-25 percent of the profit. Since profits have not grown as quickly in recent years, the dividend growth has also slowed.

The price of the Fresenius stock has fallen sharply in the past 3 years. Since the dividend yield moves inversely to the stock price, it has increased as a result of the decline in price. The Dividend Turbo on Dividendstocks.cash shows you the current and historic dividend yields of Fresenius. The current yield is almost twice as large as the average of the past 5 years. From a dividend perspective, Fresenius is clearly undervalued.

The Fresenius stock in the Dividend Turbo

Thanks to the low payout ratio, Fresenius consistently achieves a positive amortization power which means that there is still a cash surplus even after investments have been made and dividends have been paid. The amortization power has also increased over the years and was particularly high in the current fiscal year. The free cash flow of the current fiscal year of 4 billion euros is more than twice as large as it was last year (1.8 billion euros). However, since this increase is a result of one-time effects, next year’s free cash flow will likely not remain at such a high level.

Since Fresenius spends just half a billion on dividends, there is plenty of cash left at the end of every year. This conservative payout policy ensures that the dividend will be safe even in difficult years.

Development of the amortization power of Fresenius

The debt of Fresenius on the other hand, has increased considerably in recent years and amounts to more than 42 billion euros. Fresenius has a current cash position of 2.7 billion euros.

Development of the indebtedness of Fresenius

The interest owed on this debt amounted to 881 million euros last year (Annual Report 2019: page 165). The interest payments eat up about 19 percent of the operating profit which is a burden on the earnings of the company. However, the earnings stability significantly reduces the risk that stems from the debt. Thanks to its high cash flow surplus, Fresenius does not have to worry about not being able to service its debt. The consistently positive amortization power also puts Fresenius in a good position to reduce its debt if necessary. I therefore do not think that the debt puts the dividend at risk.

Fresenius heavily uses acquisitions to grow its revenues and spends large sums of cash on these purchases. In some years, acquisition spending exceeds the spending on all other types of investments. This forces Fresenius to frequently borrow money despite its high cash flows. As a result of these acquisitions, goodwill has also increased drastically. Since 2019, the goodwill on the balance sheet even exceeds the equity. This poses the risk of massive write-downs if the acquired companies should prove to be worth less than initially thought. Those write-downs would in turn weigh on the profits of Fresenius. Bayer had to deal with such a scenario just a few months ago.

Fresenius had to experience firsthand that acquisitions do not always turn out to be successes. In 2017, Fresenius signed a deal to purchase the American pharmaceutical company Akorn. Shortly after signing the deal, the financial results of Akorn deteriorated. This prompted Fresenius to abandon the acquisition for which it was sued by Akorn. To the benefit of the shareholders of Fresenius, the company won the lawsuit and did not have to acquire Akorn. Had they lost the lawsuit the result would have been disastrous. Akorn filed for chapter 11 bankruptcy in May of 2020 which means that Fresenius’ 4 billion euro investment would have been lost had the deal gone through.

Is the Fresenius stock undervalued?

The Fresenius stock has lost half of its value from its peak of 80 euros in 2017. As a result, the P/E ratio has fallen from 23 to 12. Such a low P/E ratio is very unusual for a company in the health care sector with stable earnings.

To determine the fair value of the Fresenius stock, I use the Dynamic Stock Valuation on Dividendstocks.cash. I choose a 10-year time frame for the valuation period.

In the early 2010s, the stock was trading very close to its fair values. Starting in 2014, the price then diverged from the fair values which means the stock started to become overvalued. Since 2018, the stock is once again trading below its fair values. The dividend fair value of about 71 euros implies an upside potential of 80 percent. I do not use the cash flow fair value due to the extraordinarily high cash flow in 2020 as a result of one-time effects. The fair value based on profits is lower than the one based on the dividend yield, but at 54 euros, it still implies an upside of 35 percent. The historical valuation therefore shows that the Fresenius stock is significantly undervalued.

The Fresenius stock in the Dynamic Stock Valuation

Conclusion: The Fresenius stock is significantly undervalued

In my opinion, the Fresenius stock has been unjustly punished by investors in recent years. The decline in price can partly be justified with the slowing growth and the Akorn embarrassment, but the market reaction seems excessive. The business model is still intact and delivers stable earnings. A P/E of 12 for a company with a safe business model that also has growth opportunities is too low in my opinion. I therefore consider Fresenius to be undervalued. While you wait for the market to realize the true value of the stock, you can collect a safe and growing dividend.