ML:
Valuation could contract with new competition
FDA approved Abbott’s DHA & ARA oils for use in infant formula, which could put
competitive pressure on Martek’s core business & valuation could contract. We
see 3 new risks with possible new competition: 1) Martek could lose its 2nd largest
US customer in infant formula, 2) Ross may not double its levels of DHA and
ARA, as the Street expects, & 3) there could be a competitive source of DHA and
ARA leading to market share loss and difficulty raising prices. Reiterate SELL.
Infant formula monopoly at risk, fair value could be $15-18
We believe there is a high probability Ross may now switch to its own product. If
MATK’s effective monopoly on the US infant formula business is broken, it should
no longer deserve a premium multiple & valuation could contract, which could
lead to a fair value of $15-18. Based on a high probability for Ross to switch, we
lowered our F07 EPS to $0.58 from $0.61 and F08 declines to $0.67 from $0.79.
2nd largest customer, upside from increased levels at risk
Martek indicated its customers have not yet notified it of intentions to switch to
Abbott’s products. But, Martek’s 2nd largest customer, Ross, which accounts for
about 25% of US revenues by our calculation, could switch to their own product
and is unlikely to double the levels of DHA and ARA used in its formulas. As a
result, we are lowering our peak US formula estimate to $175 MM from $210 MM.
Market share losses and price constraints possible
Martek’s supplements are used in ~85% of US infant formula & are expected to
reach 100%. If a competitor launches at a lower price, which is likely given the
cost of fish oil, Martek may lose share, may not be able to raise price & may even
cut price to stay competitive. But, Martek believes customers who switch
DHA/ARA sources will owe a 3% royalty on wholesale sales, limiting operating
profit impact. Regardless, risks related to the core business are now higher. |
