Business description

CIECH, which is based in Warsaw, is an international chemical group with factories in Poland, Germany, Spain and Romania, >3,000 employees and a worldwide customer base. It is the 2^nd largest manufacturer of sodium carbonate and sodium bicarbonate in the EU, the no 1 manufacturer of evaporated salt in Poland, the no 1 supplier of sodium silicates in Europe, the largest Polish manufacturer of plant protection products, and a leading Polish producer of polyurethane foams in Poland. CIECH’s products are crucial elements in different industries incl. Construction, Automotive, Agriculture, Chemical, Food and Pharma. They are used in the production of articles necessary in everyday life.

In 2021, Poland was CIECH’s largest geographical market with a share of 51%, followed by other EU countries (45%), other Europe (2%) and Asia/Africa/Other (2%). The Soda segment was the company’s largest one by far and accounted for 66% of total sales and c. 81% of adjusted EBITDA. Its products soda ash, sodium bicarbonates and salt are used in the production of flat glass, glass packaging, silicates, detergents, animal feed, food, and water treatment solutions, among others. Other segments include: 

Agro (crop protection products, herbicides) – 14% of total sales in 2021 and c. 16% of adj. EBITDA

Foams (Polyurethane foams that are mainly used in the production of furniture and matrasses) – 11% of revenues and >16% of adj. EBITDA

Silicates (sodium and potassium silicates used e.g. in the production of precipitated silica, paper and welding electrodes) – 7% of 2021 sales and >4% of adj. EBITDA and 

Packaging (lanterns for vigil lights, jars) – 2% of total sales and >2% of adj. EBITDA

CIECH S.A. has been listed on the Warsaw Stock Exchange since 2005. It can also be traded in Frankfurt. Since 2014, the company has been owned by Kulczyk Investments, which belongs to the 6^th richest Pole Mr Sebastian Kulczyk. Kulczyk Investments (through KI Chemistry) bought a control stake of 51.1% in CIECH from its previous owner, the Polish state, at PLN 31 per share.

Financials

In 2021 – the last fiscal-year, for which results are available – the CIECH Group generated revenues of PLN 3.5bn (+16.3% y-o-y, 5y CAGR of 0.03%), an EBITDA of PLN 730.4m (+24.1%, 21.1% margin, 5y CAGR of -3.9%) and a net income of PLN 292.4m (+126.2%, 8.5% margin). Operating and free cash flow equalled PLN 1.3bn (2020: PLN 767.2m) and PLN 571.5m (PLN     -66.8m) respectively. Between January and December 2021, CIECH’s ROCE equalled 5.8%, while we estimate its current WACC at 14.2%, implying that the company is not generating a sufficient return on the capital employed to offset its costs of capital.

In 9M/22, the company generated revenues of PLN 3.9bn (+57.4% y-o-y), an adj. EBITDA of PLN 661.2m (+19.3%) and net income of PLN 234.5m (+0.2%). At the end of September, its net gearing equalled 56.1%.

In the last years, CIECH has paid out dividends, but not regularly. For 2022, the company paid out PLN 1.50 per share, which corresponds to a DYield of 2.9% at present.

Comment on the tender offer

On March 9, Kulczyk Investments through its subsidiary KI Chemistry Sarl announced a tender offer for all the remaining 48.86% shares of CIECH Group at PLN 49 per share, which starts on March 10 and is supposed to end on April 12. After reaching a threshold of at least 95% of the shares outstanding, Kulczyk Investments plans to delist CIECH as it believes that as a listed company it cannot “react in a fast and flexible manner to rapidly changing economic, geopolitical and regulatory environments, and turbulences on global financial and raw material markets”. 

In our view, the tender price is far too low and does not reflect CIECH’s fair value. The current share price of PLN 52.35, which is 6.8% above the tender price, implies an EV/EBITDA 2023E and P/E 2023E of 3.9x and 6.8x respectively. The 5-year hist. average EV/EBITDA and P/E multiples of 5.1x and 11.5x respectively are 31.3% and 69.8% higher. 

We expect that especially the Polish investment and pension funds, which hold approx. 27% of CIECH’s shares at present, will urge Kulczyk Investments to increase the tender price. Consequently, we advise current investors not to sell their shares in the tender and to increase their stake in the company.

In this blog post, we analyze the public finances of the EU member states that before 1990 were part of the Soviet bloc. Slovenia, Slovakia, Croatia, Estonia, Latvia, and Lithuania are already members of the Euro zone and thus do not have control over their currency. When it comes to the budget and current account deficits, we have compared the most recent data from 2021, which was affected by the pandemic, with the pre-COVID year 2019. While our analysis concludes that Poland, Czechia, Estonia and Slovenia are relatively reliable debtors, the condition of public finances in Hungary, Romania and Bulgaria looks much riskier.

Sources: Eurostat, central banks, tradingeconomics.com, Worldbank, S&P, CIA World Factbook

Especially after the PiS (Law and Justice party)-led government came to power in 2015, the Polish economy has been supported a lot through various social programs e.g. the “500+” child benefit, “Dobry Start” PLN 300 one-off support for pupils and the one-off retirement payment of PLN 1,100 “Emerytura+”. While these programs are considered negative by many economists as they stimulate consumption instead of investments, apparently they have not increased the debt level as well as budget and current account deficits in Poland as much as similar measures in Hungary. Especially a high current account deficit, which reflects imports and exports of goods and services, payments to foreign holders of a country’s investments, payments received from investments abroad, and transfers such as foreign aid and remittances, can negatively affect the foreign exchange rate of a country’s currency. On the one hand, a weak currency makes exports more profitable, however on the other makes the import of important components, the servicing of foreign debt or popular consumption goods more expensive.

Apart from Poland, Czechia is another non-Euro country, whose public finances look solid. What is particularly impressive, are its significant foreign exchange reserves, which are 3.5 times higher than in Hungary that however has a similar population. The larger the foreign exchange reserves, the better a country can fight pressure on its own currency.

In Romania and Bulgaria, especially the relatively high share of foreign currency denominated debt is worrying, which can lead to issues with repayment of debt in case the local currency significantly weakens versus EUR or USD. 

Based on the methodology of S&P, Hungary’s and Romania’s current BBB- rating is the weakest investment grade rating. The rating agency’s definition is as follows: “An obligation rated ‘BBB’ exhibits adequate protection parameters, however adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.” Estonia, whose debt only equals 18.1% of its GDP, and Czechia both have an AA- rating. According to S&P, it “differs from the highest-rated obligations only to a small degree”. Of all ex-communist EU member states, Slovenia has the best S&P credit rating (AA).

Business description

Founded in 1954 as a state-owned company, Krka, which is based in Novo Mesto/Slovenia, is among the world’s leading producers and developers of generic pharmaceuticals. In its own and leased production and R&D facilities in Slovenia, Croatia, Germany, Poland, the Russian Federation and China, the company employs c. 11,500 people. Generic medicines are original medicines, which have never had a patent protection or whose patent protection has expired. Both contain the same active pharmaceutical ingredients and are equivalent in terms of quality. So-called Super Generics are generics with an added value compared to their original drugs e.g. with improved pharmacokinetics, delivery or therapeutic effects. Their significant advantages are a shorter development (3-4 years vs. 12 years) and much lower costs (c. USD 50m vs. USD >1bn).

Krka distributes 800 pharmaceutical products and 600 formulations based on 250 APIs. It operates in the following business segments: Prescription & non-prescription pharmaceuticals targeting e.g. the areas cardiovascular diseases, central nervous system, gastrointestinal system, pain, infections, digestion, oncology and urinary tract (83.7% and 8.8% of total sales in 2021 respectively); Animal Health products (5.2%); and, through 100% subsidiary Terme Krka d.o.o, Health resort & tourist services (2.3%). Krka’s products, which are sold exclusively under the company’s own brands, are distributed in >70 countries worldwide. In 2021, 94% of total sales stemmed from outside Slovenia, thereof 35.1% from the East Europe region (former CIS region incl. Russia & Ukraine), 22.5% from Central Europe (mainly Poland, Czechia, Hungary and Lithuania), 19.5% from West Europe (e.g. Germany), 13.4% from South-East Europe (mainly Croatia, Romania and Bulgaria) and 3.4% from other markets in Africa, the Middle East and Asia. 

Krka spends 9.9% of its yearly sales on R&D – is mainly related to oncology and autoimmune diseases, thus two of the largest segments of the global Pharma market – compared to 9.7% in case of its listed regional peer, Hungarian Gedeon Richter. It has c. 170 products in the pipeline in different R&D phases and has received/submitted patents for more than 210 innovations.  

Krka, which has been listed since 1997, can be traded on the stock exchanges in Ljubljana, Warsaw and Frankfurt. The company has paid out a dividend in each of the last 11 years and since 2012 its DPS has increased at a CAGR of 13.8%. Only in 2017, the DPS was slightly lower y-o-y.

Krka’s largest shareholders are entities associated with the Slovenian state, which own in total 26.7% of the company’s shares and 35.7% of its votes. According to marketscreener.com, the company has both US-based and Western European investment funds as shareholders. The Norwegian sovereign wealth fund holds a stake of c. 0.8%. Treasury shares make up 5.5% of all shares outstanding.

Management’s 5-year guidance foresees a sales CAGR of at least 5% and an EBITDA margin of min. 25%.

Latest financials

In 2021, Krka, which before the pandemic grew at a 5y CAGR of 4.6%, produced c. 16bn (+2% y-o-y) pills and generated revenues of EUR 1.57bn (+2% y-o-y). With 18% and 9% respectively, the regions Slovenia and Other overseas countries reported the highest growth y-o-y. In 2021, the company introduced 16 new products. Drugs related to cardiovascular diseases accounted for >50% of all prescription drug sales. 

Despite serious COVID-19-related shortages of materials and transport issues, between January and December 2021 Krka’s EBITDA reached EUR 463.6m (-7.7% y-o-y; 29.6% margin) and net income EUR 309.2m (+6.3%; 19.7% margin) respectively. While operating cash flow amounted to EUR 386.1m (2020: EUR 360.8m), free cash flow equalled EUR 13.5m (EUR 251.2m). In 2021, Krka generated a ROCE of 13.7% compared to 12.1% at Gedeon Richter.

For the first nine months of 2022, Krka reported revenues of EUR 1.24bn (+5.6% y-o-y). In Ukraine, where the company is the No 2 provider of generics, sales declined by -14% y-o-y, but in Russia, where it is No 4, they grew by 5%. In 9M/22, EBITDA reached EUR 314.2m (-10.9% y-o-y; 25.3% margin) and net income EUR 300.9m (+25%; 24.2% margin) respectively. The main factors, which affected profitability, were 9.6% higher CoGS y-o-y, 21% higher marketing & distribution expenses and a EUR 113.6m higher net financial result, which was positively affected by FX effects. At the end of September, the company’s net gearing amounted to -15.4% compared to 1% in case of Gedeon Richter. 

Summary & conclusion

In our opinion, Krka is one of the best companies in Eastern Europe, a leading global player in a growing, non-cyclical sector and can be considered a dividend aristocrat in CEE. The generics segment is highly promising as governments and healthcare institutions in many countries are cutting back on their healthcare expenses and encouraging the use of relatively cheap generic products. 

In our view, only a few CEE-based companies have such a history of earnings and dividend growth as Krka. Since its IPO, the company’s market capitalization has increased 18 times. As negatives, we consider the significant share of revenues from the CIS region (especially Russia) as well as the low share ownership of the company’s Management and Supervisory Board, which at the end of December 2021 equalled 0.12%.

While Krka seems fairly valued at present – its current EV/EBITDA 2023E multiple equals 5.8x compared to a 6y average of 5.9x – its stock is highly interesting in the long run, in our view. Currently, the dividend yield for 2022E and 2023E equals 5.9% and 6.4% respectively. The company has a long-term dividend policy, which foresees the payout of min. 50% of its net profit.