#2 Schott Pharma AG - Quantitative Analysis

Today I am bringing you the 2^nd part of my investment thesis in Schott Pharma AG. After introducing the packaging industry, studying and comparing the main glass packaging companies and analyzing Schott’s qualitative aspects, this write-up is the icing on the cake.

DISCLAIMER: This article is not a recommendation to buy or sell any financial instrument, the content is educational and my personal opinion. Each person has to make his own analysis. Any action or decision you take as a result of viewing this article is your sole responsibility.

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Executive Summary

• Revenue has grown >10% CAGR on average in the past years and it is expected to continue growing at the same pace in the mid-term.

• Margin expansion as a consequence of the product mix steady change into high-value solutions (HVS).

• Cash flow dragged by working capital and heavy CapEx investments. This is considered a temporary situation which will be turned over in the mid-term.

• DCF model shows the company might be an attractive investment opportunity at the current share price.

Schott Pharma AG reporting period starts in Q4 and finishes in Q3 of the following year. Considering the company IPO took place a little over a year, there is only a full annual report available. However, there are also available the consolidated financial statements for the 19/20, 20/21 & 21/22 reporting periods. Let’s start with the income statements.

Income Statement

Revenue

The revenue for the last period reported (2022/2023 from now on referred to as 2023) amounted €898.6 million, up 9.4% YoY. As it can be observed from figure 1, Schott Pharma AG revenue continued growing in the aftermath of Covid-19 while the pharma industry was in a downcycle and the pharma tools companies suffering from the inventories destocking and lack of funding. Note, that during Q3 2024 reporting the company upgraded the FY24 revenue growth guidance to 11%-13%. Hence, the FY24 revenue will be in the range of €997.5 - €1015.4 million.

Revenue product distribution

Schott Pharma AG reports revenue in two different segments: Drug Containment Systems (DCS) and Drug Delivery Systems (DDS). It can be observed in figure 2 how the latter has been gaining revenue share growing at a 35% CAGR since 2020.

The DDS portfolio consists of pre-filled and ready-to-use packaging solutions, which are known as the HVS. These are the most profitable products of the portfolio so their increasing revenue share would explain margin expansion. Schott Pharma AG reported in Q3 2024 a HVS revenue share of 53% a confirmed the mid-term target of >60% of revenue coming from HVS products.

Geographical revenue distribution

53% of the company revenue is generated from customers in EMEA region while the remaining share of revenue is distributed among America and Asia & South Pacific. Two trends can be observed among the four reported regions: steady revenue growing in the EMEA & North America and stagnation in Asia and South America.

Margins

Margins have been relentlessly improving during the last 4 years thanks to the growing revenue share coming from the High-Value Solutions (HVS) segment. Although, FCF margin has reached its lowest reported value at 0.7% in 2023 due to the several ongoing expansion projects the company is executing. The core spending phase of these projects has already been completed and FCF margin has improved in 2024, being approximately 9% for the first nine months.

Operating Profit

EBIT has been growing at a 24.8% CAGR since 2020, outgrowing the revenue (11.4% CAGR during the last 4 years). This shows the operating leverage the company is experiencing as it scales its operations, which I expect to continue as expansion come into production.

The operating expenses, especially the R&D, showed a lower YoY growth than revenue (blue line in figure 6). The low yearly expense of €26.8 million growing at 10% YoY - approximately 3% of sales - reflect the low innovation pace present in the glass packaging sector due to the usual arrangement of partnerships between customer and supplier to develop customized solutions.

Net Income

Net income reached €151.9 million, growing at the same pace as the operating profit. Since 2020, the EPS have doubled from 0.51€ per share to 1.01€ per share and a net income margin of around 15%.

Balance Sheet

Schott AG retains a 77% ownership stake in Schott Pharma AG following the IPO. As a result, Schott Pharma continues to be integrated into the group's centralized treasury and cash management systems. This integration allows Schott Pharma to participate in Schott AG's unified credit and hedging structures. Additionally, Schott Pharma is part of the group’s cash pooling arrangements, enabling more efficient cash flow management across the Schott corporate structure.

Consequently, a summary of some FY23 relevant financial parameters will be presented at group and company level. See Table 1 below,

A majority of financial ratios show healthy values. The only exception is the Net debt/FCF ratio due to the large CapEx investment which has been depressing the FCF in the last years as explained before. For Schott Pharma AG, if we consider a 10% FCF margin for FY24 and €1000 million in sales (guidance range midpoint), then we can expect around €100 million FCF for FY24, reducing the Net debt/FCF ratio just under 1.5.

Cash Flow Statement

Capital Allocation

Schott Pharma AG has shown an organic reinvestment rate of approximately 100% during the last 4 years. All the FCF has been reinvested in expansion projects and no acquisitions have been performed, which has depressed the FCF to a bottom of €6.4 million in 2023.

In figure 4 the status of the main projects in which capital has been invested are displayed: three new production facilities in Hungary, Serbia & the USA and the expansion of an existing one in Germany. The one in Germany is already in operation while the facilities in Hungary and Serbia are about to start ramping-up production in the last stages of the expansion. Although it is expected that for the facility in the USA in which Schott Pharma AG is investing €371 million, groundbreaking will take place in 2025. Hence, I don’t anticipate CapEx to drastically decrease anytime soon.

Working capital

The cash conversion cycle (CCC) has worsened as a consequence of the destocking cycle the pharma industry has undergone after Covid-19 during the last 1-1.5 years. See Figure 9.

As the situation normalizes, inventory management should improve, consequently improving the CCC and free cash flow to the firm (FCFF) that we will examine later on.

FCFF Generation

Schott Pharma has not generated great flows of free cash flow to the firm mainly because of the CapEx and net working capital investments committed as the operations scaled.

As it can be observed from figure 10, CapEx has almost tripled since 2020 while the NWC investment has doubled in the same period. Once the expansion cycle is normalized, I expect that if Schott Pharma executes its midterm roadmap as expected, FCFF will explode in the coming years as a consequence of the revenue growth, operating leverage, working capital improvement & CapEx reduction.

Capital Efficiency

The returns on the equity (ROE) and capital employed (ROCE) of Schott Pharma AG are consistently superior to 15%, sometimes in the vicinity of 20% as shown in figure 11. Similarly, ROIC varies within the 12-15% and the average ROIIC since 20 is approximately 12.3%.

Special focus should be placed on Schott Pharma AG's Return on Invested Capital (ROIC). Although ROIC currently exceeds the Weighted Average Cost of Capital (WACC), it is temporarily under pressure due to the company's significant expansion phase. Once this development phase concludes, ROIC is expected to improve as the numerator in the ratio (net operating income) begins to outpace the denominator (invested capital). This trend is common following substantial CapEx cycles in industrial companies: initial returns are compressed as the capital base grows, but profitability expands significantly as these investments mature and deliver higher returns over time.

Dupont Analysis

It can be observed from figure 12 that Schott Pharma ROE composition has shifted slightly during the period of scope: the adjusted income margin has improved year over year while the assets turnover has come down, showing a slight improvement in 2023 vs 2022.

This can be explained by the shift toward HVS products, which are higher price and lower volume. This trend has been contributed by customers´ inventory destocking.

Valuation

I have run a 10-year DCF with my assumptions reflecting what I consider would be the most likely and plausible scenario for the company. The financial assumptions can be observed in the figure below.

The fair share value is estimated to be 36.49 euros, offering a 23% discount with respect to the current share price.

Other assumptions and justifications:

• Revenue growth: Over 10% mid-term and then decrease to sector average and further.

• Operating margin expansion due to HVS sales representing a larger share of the total company revenue.

• CapEx: return to before Covid-19 sector average. Based on Stevanato Group historical CapEx/Revenue data.

• Investment in NWC: neutralization between company scaling needs and temporary customer destocking

Closing Remarks

Overall, in addition to all the industry dynamics and business qualitative aspects I have covered during the several write-ups on the pharma glass packaging industry, I find Schott Pharma AG fundamentals and story quite compelling.

However, there are some aspects which sow doubt to consider starting a position:

1. Lack of management alignment and track record.

2. Complicated financials due to the centralized functions at Schott AG.

Consequently, I don’t think we can label Schott Pharma AG as a no-brainer opportunity but the opportunity cost of other companies should be evaluated before initiating a position.

DISCLAIMER: This article is not a recommendation to buy or sell any financial instrument, the content is educational and my personal opinion. Each person has to make his own analysis. Any action or decision you take as a result of viewing this article is your sole responsibility.

Since Schott Pharma AG appears to be the most promising investment opportunity in the pharma glass packaging sector, I’ve decided to put further research on its competitors, Stevanato Group and Gerresheimer AG, on hold for now. Consequently, I'll also pause my coverage of this sector and shift my focus to exploring other sectors and companies that may offer potential investment opportunities.

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