Bayer AG produces and markets healthcare and agricultural products, and polymers. The company manufactures products that include aspirin, antibiotics, anti-infectives, and cardiovascular, oncology, and central nervous system drugs, over-the-counter medications, diagnostics, animal health products, crop protection products, plastics, and polyurethanes.

Investment Thesis

We reiterated our buy rating on Bayer with a price target of €120.60.

The shares are down 16.75% year-to-date. This is below the 14.00% drop we have seen in the Dax Index since the start of the year.

The reason for the underperformance in the shares when compared to the benchmark is the result of a lack of positive catalysts to push the price higher than the market in 2016. However, we are of the opinion that even without new drugs being launched during the year, the shares are undervalued.

Looking beyond the current turmoil in equity markets and taking a medium term view, we expect Bayer to be at the forefront when it comes to launching new drugs. Our model is conservative because it doesn’t include any new sources of revenue in the years ahead which is very unlikely given Bayer’s history of new launches over the years.

In the meantime, we expect its current success story, Xarelto, (which is the Group’s flagship drug which is a blood thinner that prevents the formation of blood clots) to contribute handsomely to the profitability of the Group.

We like Bayer because:

* The Group recently launched new pharmaceutical products. We expect to see further growth in sales from existing products

* Bayer is a blue chip company with a history of successful launches of new drugs and diversification (through crop science and material science)

* The healthcare and crop science business are expected to continue to generate growth for the Group

* Bayer has a history of growth through acquisitions. We expect the model to remain the same and the Group to pick up new businesses at a better prices due to the weakness in global growth forecasts

* We see descent capital gains in the share price over the medium term without the Group reporting supernormal profits in the years ahead

Our concerns are as follows:

* No new drugs in the Phase III pipeline for 2016

* Difficult market conditions in Latin America are weighing on performance in the material science business referred to as Covestro. The company supplies key industries around the world mainly with premium polyurethane foam used in the automotive, construction and electronics sectors, as well as the furniture, sporting goods and textiles industries.

The positive news is that management is in discussion for an exit out of this business. On a positive note what we like about management is that if it has a business which is a drag on performance, it gets rid of it. We have seen it in the past and we continue to see it now. This is a positive thing because management cuts its losses and does not continue ‘hoping’ for an improvement if it doesn’t see a turnaround in the market.

* No short term catalysts within the company itself to justify a strong rebound in the share price apart from external factors such as more accommodative central banks, a recovery in the commodity markets and a stop to the slowdown in emerging markets, particularly China.

* Turmoil in equity markets could result in a further reduction in the price from its current levels 

Other; 

We are assuming no further weakness in the Euro in 2016. If the Euro had to weaken further, Bayer would benefit from this and result in a higher sales forecast.

This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.