Description

SCHOTT Pharma AG & Co. KGaA (1SXP GR)

Thesis

• Pharmaceutical packaging manufacturer is seeing improvement in its secular growth prospects; trades at a discount to its closest competitor; upside kicker from success of GLP-1s

Investment Highlights

Accelerating Business in Attractive Industry

• Industry growth is accelerating from historical MSD range to 10%+; driven by increasing prevalence of biologics, GLP-1s, and penetration of High Value Solutions (“HVS”, higher price/value delivery solutions like autoinjectors, pens, and ready-to-use vials + cartridges)
• SCHOTT’s HVS are driving double digit consolidated revenue growth
  • HVS as a % of total revenues increased from 39% in 2022 to 48% in 2023; management expects HVS ~50% for 2024 and to reach 60% over the medium-term
  • HVS growth rates are ~3x the growth rate of non-HVS solutions
  • HVS are not only accretive to growth, but to margins as well; we estimate HVS margins of ~35% vs low 20% range for non-HVS
• Industry is an oligopoly with solid pricing power
  • Only a small number of companies can reliably fulfill large global contracts increasingly demanded by global pharma companies
  • Industry is dominated by SCHOTT Pharma, Stevanato, Gerresheimer, and Becton-Dickinson; adjacent (albeit less direct) suppliers include West Pharma and Aptar Group
  • Fulfillment of global contracts requires meaningful access to capital; this will further entrench the top suppliers at the expense of smaller regional competitors; this is particularly true in HVS so the top tier suppliers will have increasing access to both the faster growing and higher value added subsegments of the industry
  • Customer are largely price insensitive, particularly in HVS; cost of delivery system is typically immaterial relative to the cost of a biologic or GLP-1; the most important metrics are quality and ability to provide steady supply; this favors the large suppliers and leads to steady, predictable pricing power
• SCHOTT has solid market shares across most pharma delivery modalities: #1 in ampoules, #1 in vials, #2 in cartridges, #3 in glass syringes, #1 in polymer syringes
• Trend from bulk vials/cartridges → ready-to-use vials/cartridges should provide meaningful growth tailwinds
  • Bulk vials/cartridges currently represent >95% of the vials market; bulk vials have to be sterilized prior to use (by pharma manufacturers, fill-finish companies, CDMOs, etc.)
  • SCHOTT (and its competitors) have begun vertically integrating into sterilization and shipping ready-to-use (“RTU”) vials/cartridges
  • RTU vials/cartridges are a HVS, and sell at a substantial premium with accretive margins
  • SCHOTT and its competitors went through a similar transition with syringes over the past couple of decades, and RTU syringes went from 10% market share to >95% today
  • We expect that a similar long-term shift is now beginning for vials/cartridges; this could provide multi-decade growth tailwinds
• On-track for medium-term targets
  • Revenue growth 10%+
  • EBITDA margins 30%+ (up from current 26-27%)
  • 23-25% (up from 20%)
  • SCHOTT delivered vs fiscal 2023 consensus despite emerging concern over destocking in the bulk vial segment of its business (see Risks section)
• Free cash flow should improve meaningfully going forward; company is currently investing heavily to expand capacity in HVS and for GLP-1s, specifically; should start to see meaningful acceleration in free cash flow starting in 2026
• Solid returns on capital: mid-teens ROIC (15-16%), 20-25% ROE
• Strategic supply agreement with parent SCHOTT Group, a major global glass producer, ensures access to key manufacturing input at attractive terms going forward

Secularly Growing Industry

• Attractive growing industry in pharma/biologics
  • Biologics are accounting for a disproportionate share of pharma industry growth
    • FDA approval of biologics went from 28% of total approvals in 2021 to 50% in 2022
    • >50% of overall pharma industry R&D is for biotech vs 30% of total pharma industry sales for biotech
  • Biologic strength benefits syringes, the preferred delivery modality
    • Estimated 2022-27 biopharma injectable CAGR of 15% (per Stevanato/IQVIA)
  • Biologics have a heavy reliance on glass vials; many biologics are caustic to plastic containers and sensitive to light and metals (which favors glass containers, where GXI has a strong position)
  • Seven of the top 10 selling drugs globally are injectables

GLP-1 Accelerates Growth with High Visibility

• GLP1s provide an upside kicker
  • Company is one of a small number of providers for GLP-1 packaging (syringes and autoinjectors)
  • €1bn of current GLP-1 backlog; more likely to come
  • GLP-1 business is margin accretive
  • GLP-1s (diabetes, weight control) expected to continue to show strong continued growth over next few years; currently ~$20bn market, expected to grow to $75bn+ by 2030
  • Injection is currently the preferred modality for GLP-1s; injection is the only available modality for newer GLP-1s although some older formulations available in oral
    • We believe that injection is likely to remain preferred modality for diabetics; oral may take share for weight loss purposes

Valuation Discount and Market Discovery

• US investors are just beginning to wake up to the secular growth story around key pharma packaging manufacturers
  • VIC writeups as a proxy: one writeup (Jan 2023) on Stevanato, one writeup (Mar 2004) on West Pharma, no writeups on SCHOTT Pharma, no writeups on Gerresheimer
  • To-date, there haven’t been a lot of ways to play the favorable themes
    • SCHOTT Pharma is a recent carve-out of its parent SCHOTT Group; went public in Sep 2023
    • Stevanato (Italian) has only had a US listing since mid-2021
    • Gerresheimer has been public for >15 years; however, as the worst-managed (until recently) of the large operators it was a poor public facing representative for the industry; low-growth, poor FCF, focus on commodity grade solutions, etc.
  • We believe that SCHOTT (and its competitors) represent an attractive discounted way to play the GLP-1s with lower drug-specific risk
• SCHOTT Pharma trades at a 4-turn discount to its closest competitor, Stevanato
  • 20x EBITDA vs 24x for Stevanato
  • This despite an arguably equal-to-better profile
    • Similar EBITDA growth expected over 3-yr time horizon
    • SCHOTT has a higher attribution to HVS than Stevanato (48% vs 33%); EBITDA multiples are typically highly correlated with % of revenue attributable to HVS
    • Equal-to-better ROIC and ROE

Comparable Re-rating Example in Industry

• Adjacent (not direct) competitor West Pharma provides an encouraging case study for how a combination of solid revenue growth, improved margins, and expanding ROICs can drive meaningful multiple expansion
  • For many years, West Pharma has been one of the few ways for investors to play the theme of a quality business benefiting from pharma packaging tailwinds
  • West Pharma 2013-23
    • 8% revenue CAGR
    • 900bp of margin expansion
    • 1200bp of ROIC expansion
  • EV/EBITDA multiple went from ~10x → 26x

Business

• Drug Containment Solutions (~75% of revs): ampoules, vials, and cartridges
• Drug Delivery Systems (~25% of revs): glass syringes, polymer syringes

Upside/Downside

• 22x EV/EBITDA target multiple; 2-turn discount to competitor Stevanato, 6-turn discount to competitor West
• Assumed ~€150mm in normalized FCF

Risks

• Vials destocking proves more persistent than expected
  • All of the primary pharma packaging competitors have called out headwinds in recent quarters from destocking in bulk vials
  • COVID vaccines drove a huge increase in demand for vials; many/most customers stockpiled as a result and are now sitting on excess inventory
    • For instance, SCHOTT Pharma just reported a 7% decline in its Drug Containment Solutions segment, primarily as a result of this destocking
  • The general expectation seems to be that destocking headwinds should abate after 2024 1H, however, most of the competitors have also acknowledged they don’t have full visibility into customer inventory levels; it is also unclear whether customers will go back to pre-COVID levels of inventory or will carry permanently higher levels going forward
  • Once SCHOTT and/or competitors signal the end of the destocking is in sight, it could remove a meaningful overhang on the stock
• GLP-1 momentum stalls

Catalyst

Destocking headwinds abate. Improvement in FCF. Improved visibility. Valn gap with Stevanato dissipates.