Anatomy of a Good Company: Sartorius
Jamie Ross, Fund Manager of Henderson EuroTrust, provides a snapshot of the typical analysis undertaken on every company considered for the portfolio. In this case, he explains the rationale behind the inclusion of Sartorius.
8 minute read
- Sartorius is one of the world’s leading biopharma equipment manufacturers. The company operates in an industry where strong pricing power, high barriers to entry and an oligopolistic market structure create the necessary conditions for high margins and attractive return on invested capital.
- It is rare to find businesses with high margins, attractive returns and strong growth drivers trading at a reasonable valuation; the recent sell-off in high-quality growth companies has created the opportunity for us to invest in Sartorius.
There tend to be many features that most good companies have in common, but there are myriad characteristics and features to analyse that will be unique to each and every business. By undertaking a detailed analysis of the 50 or 60 companies we have on our radar (a portfolio of ~40 positions and a watch list of 10-20 names), we try to ascertain whether a business is a good business and if so, whether now is the right time to be invested or not.
Sartorius is a German life sciences company headquartered in Göttingen. Having long admired Sartorius, we initiated a position in May this year after a heavy derating in its equity valuation - which we attribute almost entirely to the ongoing rotation from ‘growth’ to ‘value’ companies.
Sartorius’ predominant business is producing and supplying equipment for the manufacture of biologic drugs for pharmaceutical companies. It also has a smaller business which sells professional laboratory equipment. I will focus on the first and largest of these two businesses, an area that Sartorius refer to as Bioprocess Solutions (BPS): this part of the business accounts for around 80% of group sales. There are several features of the BPS business that combine to produce strong margins and attractive return on invested capital for Sartorius - I will go through the most important of these features in turn.
High margins and return on invested capital
1) Sartorius provides assurance benefits for its customers
Around 1/4 of BPS revenues come from equipment sales (fermenting machines for example) whilst 3/4 of revenues comes from the sale of single use technologies or SUTs (filters and bags for example). This is not a true razor/razor blade model, but the practical reality is that customers are very likely to buy equipment and consumables largely from the same supplier. Interestingly for a pseudo-razor/razor blade business model, Sartorius is able to earn decent gross margins on the equipment sales (~30%) in addition to very attractive gross margins on the sale of SUTs (~50-70%). This bears an interesting comparison with other razor/razor-blade models that tend to generate no/low gross profit from equipment sales.
Sartorius’ customers are the biopharma companies. It is absolutely crucial that the production of a biopharma product occurs in a consistent and uncontaminated environment. Sartorius’ products have a key role to play in this. There is very significant value attached to this assurance benefit; customers are focused on the assurance benefits provided by a Sartorius product rather than the cost of that product; this gives naturally strong pricing power to the business.
2) They sell a small but crucial element of the biologic equipment/manufacturing process
Biopharma customers handle highly valuable products and generate very high gross margins (80-90%). This means that the cost of equipment is a very small part of the overall cost of production for a biopharma company and gives Sartorius and its peers strong pricing power.
The Biopharma industry is relatively young and expertise around production processes is relatively under-developed. The first mainstream biopharma product was Insulin which was commercialised in the 1980s vs the chemical pharma industry that has been running for more than 100 years and where production expertise is therefore much more mature. Furthermore, the complexity of biopharma molecules is high – with thousands of atoms vs Aspirin for example that is 20-30 atoms. Sartorius, as a biopharma equipment supplier, can make a significant impact on the end customer’s economics when it comes to output, efficiency, and product feasibility. Customers choose their equipment suppliers based on these factors; performance and reliability is much more important than price.
3) Long development cycles and regulatory scrutiny create sticky/predictable demand patterns
Sartorius has an intimate relationship with customers and is closely involved with design, implementation, and consultancy of the process for new product development and production. They work with a customer from preclinical trial phase through to commercial production. The lifecycle of a BPS order begins when a customer enters a pre-clinical phase for a new biopharma product. At this stage, the biopharma customer will decide on their bioprocess equipment suppliers and the choices they make at this stage have a significant bearing over the equipment suppliers that will be used over the lifetime of the product (thus the next 10-15 years). Once a supplier has been selected by a customer and certified on a product, the regulator is not likely to allow the biopharma company to change a machine or filter without recertification once it moves to the commercial phase. This makes Sartorius’ business extremely sticky.
Due to the regulatory environment, barriers to entry, both in equipment and consumables, are high. The willingness of the customer base to cut corners is very low. Why would a biotech company with 80-90% gross margins push hard for cost savings in an area which poses such a high risk to successful production? Track record and customer relationships are therefore key competitive advantages for biopharma process equipment suppliers.
4) The industry is consolidated with only gradual movements in market shares
The Bioprocess equipment market has developed an oligopolistic market structure with Thermofisher, Sartorius, Merck and Danaher commanding a combined 75% market share. They all have very strong pricing power and tend to compete with each other on innovation and product breadth rather than on price. With high barriers to entry, this current market structure looks to be robust.
5) Scale, breadth of product offering, and an international presence are required for success
To be successful in winning business from the large biopharma companies, product and geographical breadth is an important factor. When a large biopharma company wants to product a biopharma product in more than one country, they will tend to copy process flow and equipment across their different sites. Therefore, to compete effectively as a biopharma process equipment supplier, you need to have a fully international setup with proximity to the regional production sites of the largest potential customers. This acts as a barrier to success for smaller players and helps to entrench the market positions of the largest, best-established equipment suppliers. Sartorius has a best-in-class breadth of product offering.
High levels of growth
In addition to generating high margins and return on invested capital, BPS also drives strong levels of structural growth for sartorius. The main drivers of growth for Sartorius’ biopharma equipment business are as follows.
1) An ageing population and continued innovation drives growing demand for pharma products
In 2021, there were around 1bn people over the age of 60. According to the United Nations, this figure is likely to double to 2bn by 2050; a 2.4% CAGR in the over-60s population. New innovation results in new products being launched to tackle unmet medical needs. These two factors should ensure a ~3-6% growth rate in pharma industry revenues over the medium to long term.
2) Biologics are gaining share of pharma end markets
In 2021, biologics accounted for 34% of the pharma end market and according to ‘Evaluate Pharma’, biologics’ share should grow to 37% by 2026. This should drive biologic growth of a few percent more per annum than overall pharma growth over the medium term. Sartorius guide to a 10% CAGR in the biopharma market from 2021 to 2026.
3) Single Use Technologies (SUTs) are gaining share of biopharma production
SUTs offer significant advantages versus conventional stainless-steel devices. In general, SUTs have lower capex/opex needs over the lifecycle of a biopharma product, they reduce the risk of cross-contamination, and they offer greater flexibility than stainless-steel devices. Construction costs are typically 25-35% lower, time-to-market 30-50% lower, energy cost 55-6% lower and water cost 65-75% lower. There will remain a part of the market where stainless-steel devices make more sense (high volume vaccine production for example), but Sartorius expect SUT penetration to grow from 35% to 75% over the medium term. Given Sartorius’ long-standing focus on SUTs, this should result in growth for Sartorius above the DD% level expected for the biopharma market.
4) Biosimilars will outgrow biologics over the medium term
Another factor that should boost growth for Sartorius is the robust outlook for biosimilar growth. SUTs tend to be the preferred platform for biosimilars (time to market is of the upmost importance) and Sartorius only have a limited presence serving the soon to be off-patent major blockbuster biologics. Biosimilars are expected to grow by a 30% CAGR in €bn terms out to 2024; Sartorius are benefitting from this and should continue to do so.
Please read the following important information regarding funds related to this article.
- If a trust's portfolio is concentrated towards a particular country or geographical region, the investment carries greater risk than a portfolio diversified across more countries.
- The trust may have a particularly concentrated portfolio (low number of holdings) relative to its investment universe and an adverse event impacting only a small number of holdings can create significant volatility or losses for the trust.
- Where the trust invests in assets which are denominated in currencies other than the base currency then currency exchange rate movements may cause the value of investments to fall as well as rise.
- This trust is suitable to be used as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this trust.
- Active management techniques that have worked well in normal market conditions could prove ineffective or detrimental at other times.
- The trust could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the trust.
- Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- The return on your investment is directly related to the prevailing market price of the trust’s shares, which will trade at a varying discount (or premium) relative to the value of the underlying assets of the trust. As a result losses (or gains) may be higher or lower than those of the trust’s assets.
- The trust may use gearing as part of its investment strategy. If the trust utilises its ability to gear, the profits and losses incured by the trust can be greater than those of a trust that does not use gearing.