Long report from JP Morgan, via Yahoo:
JP Morgan raises Hoechst to Buy - "Value Case Restored"
Research issued by J.P. Morgan
Summary
We are upgrading our recommendation on Hoechst to BUY and raising our price target to DM 110. We believe Hoechst is a remarkably cheap chem/pharma hybrid that is seeking to become a pureplay life sciences company. Last year was difficult for Hoechst stock: the shares underperformed the MSCI by 31% primarily because management's promises were not turned into actions, the pace of chemicals divestments slowed and the financial performance of HMR deteriorated.
HMR's profits have stabilised and we believe management has worked hard to reset the bar on expectations.
Looking forward, we believe newsflow on chemicals divestments should accelerate and pipeline newsflow should become more intense. We are increasingly of the view that the worst is behind the stock. Using a
sum-of-the-parts analysis, we see values for Hoechst stock of between DM 100 (nothing changes) and DM 160 (HMR reaches industry-average financial performance). Looking at this analysis on
the basis of the current Hoechst share price, HMR is implicitly valued today at 1.6 times 2000 sales and 6 times 2000 EBITDA on our estimates.
In our view, every chemicals business that is sold exposes this too low valuation and every piece of positive pipeline news shows that HMR has a positive future and should be valued as such.
Three Reasons to Upgrade the Stock Price Target DM 110 Upside of 39%
We believe almost any investment case on Hoechst stock has to address three fundamental points: when, how and for what value can Hoechst exit the remaining industrial businesses; what will
Hoechst be worth after a transformation to a pure life-sciences company; and what will happen to the financial performance of HMR?
We have studied each of these issues in detail and believe that a BUY rating is the only appropriate call on Hoechst stock.
We look at each of the three issues in detail below: Hoechst is now making good progress through its asset sale process, having tackled many of the difficult disposals first.
At the end of 1997, Hoechst had chemicals sales of DM 32.4 billion, of which DM 4.3 billion related to the last half-year of specialty chemicals sales prior to its divestment. Looking to the remaining
businesses, we expect the divestment of the DM 6.2 billion sales Trevira business (polyester) to be finalised before the end of the year, with the European portion already closed and the North American assets subject to a letter of intent.
Hoechst has announced its intention to combine Ticona (a DM 1.5 billion sales specialty polymers business) and Celanese (a DM 8.6 billion sales basic chemicals business) and prepare the business
for IPO (most likely in stages) in early 1999.
The DM 2.1 billion sales plastics division has been divided into several parts, with each going into its own joint venture by the end of this year.
The only businesses that remain - Herberts (a DM 2.7 billion sales European car paints business) and Messer (a DM 2.8 billion sales industrial gases business) - are attractive assets that could easily be divested through trade sales.
In summary, we expect that Hoechst can reduce its end-1997 chemicals sales of DM 32.4 billion to around DM 6.2 billion by 2000. We believe progress on asset disposals should accelerate from here, as Hoechst has focused on the difficult disposals first and has already established the strategic management holding company structure. We have valued each of the businesses that Hoechst wishes to sell using
trading, rather than transaction, multiples and have taken full account of any capital gains taxes that the disposals might generate.
Including those associate companies which are chemical in nature, we estimate that Hoechst could raise after-tax divestment proceeds of around DM 20 billion during the next four years, leaving the company with substantial net cash balances.
Hoechst is worth at least DM 100 (upside of 27%) and potentially as much as DM 160 (upside of 102%). We value Hoechst using a sum-of-the-parts approach to capture the value of its component
parts. This approach also allows us to take full account of the tax liabilities that may be crystallised as chemicals businesses are sold
(detailed above).
Using conservative margin and multiple assumptions, based on our estimates for 2000 for HMR (15% EBIT margins, 10 times EBITDA and 2.7 times sales) and AgrEvo (15% EBIT margins, 12 times EBITDA and 2.7
times sales), we calculate a share price for Hoechst of DM 100.
However, we believe considerable upside beyond this level exists - our valuation for AgrEvo is only half that of Monsanto (Market Performer, $55.2) - and achieving this level would add around DM
10 per Hoechst share.
Further, if HMR were to attain an industry average valuation on EBIT margins of 20% (management's target), it would add a further DM 45 to the Hoechst share price. In fixing our end-1999 price
target of DM 110, we have incorporated only a small portion of the upside that management is trying to capture.
The financial performance of HMR: stable now, improving later.
As the disposal programme reaches its conclusion, greater attention is naturally being focused on the performance of HMR, the core life sciences asset. We see two key issues as important in evaluating the
company: the patent expiry on Cardizem CD and the growth in sales from new products (the pipeline).
In relation to the Cardizem CD patent expiry, we are confident that the patent will hold at least until the middle of 1999, with patent protection until the end of 1999 a distinct possibility.
In relation to the pipeline, we are also becoming more bullish: three products really matter. Allegra has been launched and is performing strongly. The launch of a once-a-day product and Allegra-D
(with decongestant) should allow for the product's initial success to be maintained and enhanced. Arava, a disease-modifier for the
treatment of rheumatoid arthritis, gained expedited review status from the FDA a few weeks ago, which we take as a very good sign. The final product that matters, Actonel, an osteoporosis drug
licensed in from P&G (BUY, $82.1), is on track for launch in 1999.
Assuming that the pipeline plays out as we currently expect, HMR should be able to at least offset the expected decline in sales of Cardizem CD with new products from the pipeline.
In terms of timing, we expect a substantial jump in sales of new products from 2000, with a meaningful improvement in overall company sales growth from 2001. On the basis of the current Hoechst share price, HMR is implicitly valued today at 1.6 times 2000 sales and 6 times 2000 EBITDA on our estimates.
In our view, every chemicals business that is sold exposes this too low valuation and every piece of positive pipeline news shows that HMR has a positive future and should be valued as such. J.P. Morgan has acted as co- or lead-manager of an offering of securities by Procter & Gamble in the last three years. A director of J.P. Morgan is a member of the Supervisory Board of Hoechst.
|
