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Initiating coverage on Eurofins Scientific.

  • 25 Oct 16

Recommendation and upside: We are initiating coverage on Eurofins Scientific (market cap. of c.€7.2bn and a float of c.58%) with a Reduce recommendation and a target price of €393 (c.8% downside). While we acknowledge the company’s dominant position in the attractive bioanalytical industry, its robust growth prospects, superior technical know-how and its successful value accretive M&A history, we believe the current share price (saw a rally of c.26% over the last three months, primarily fuelled by solid H1 16 results and full-year guidance upgrade) fully discounts all these positives. It currently trades at a 2016E EV/EBIT of c.28x (vs. 22x of SGS and 17x of Bureau Veritas), making the valuation highly demanding. Business: Eurofins Scientific operates in the €130bn global Testing, Inspection, and Certification (TIC) market (of which c.45% is outsourced), with a presence across 39 countries. It employs a total workforce of c.25k people across c.250 laboratories and offers c.130k tests/ methods to evaluate the identity, composition, safety and purity of biological products. Unlike SGS, Bureau Veritas and Intertek (the big three in the industry), which cater to diverse industries, Eurofins focuses on the niche bioanalytical testing market (outsourced market size of c.€12bn) consisting of three sub-segments – Food & Feed testing (market size: €2-3bn; market share: c.30%), Pharma/Biotech testing (market size: c.€5bn; markets share: c.10%) and Environment testing (market size: c.€4bn; market share: c.7%), all of which offer stable and strong growth prospects (in the mid single-digit range), mainly driven by the expansion and tightening of regulations, the growing demand for improved safety and quality of food and environment, the increasing trend towards outsourcing, a burgeoning middle class and rising demand in emerging markets. In addition, it has forayed into the c.€160bn clinical diagnostics space in 2014 through the acquisition of Viracor IBT and, since then, has made aggressive strides into this area with the help of several more acquisitions. Need to know: The bioanalytical testing industry is characterised by a number of small regional players, often operating with very low margins, providing excellent opportunities for consolidation by the handful of global players. Over the years, Eurofins has shown great acumen of identifying targets at a reasonable price, successfully integrating them into its group structure and improving profitability of these acquired companies. This has driven the strong growth in both the top-line and the bottom-line, thereby creating value for its shareholders. These acquisitions have also expanded Eurofins’s geographical reach, technological base and product offerings, helping it to become a leading player in the industry (#1 or #2 position in most businesses/countries in which it operates). This aggressive acquisition strategy, however, has come at the expense of its cash generation capabilities. The situation is exacerbated by the fact that unlike SGS, Bureau Veritas and Intertek Group, Eurofins’ business model is more capital intensive (capex is c.8% of sales vs 3-6% for the big three) given its focus on laboratory testing (requires significant capex), with negligible exposure to certification or inspection businesses (which require lesser capex). This is evident in the cash flow examination of the company – while the company has been able to convert c.80% of EBITDA into operating cash flow (over 2011-15), the FCF/EBITDA conversion is decidedly grimmer (average of c.20% over 2011-15). Eurofins’ share capital is primarily held by the founding (Martin) family, through a holding company, Analytical Bioventures, which owns 41.7% of the group’s share capital and 58.5% of the total voting rights, effectively controlling the company. The family remains involved in the day-to-day operations and the long-term strategy execution, as evidenced by their strong representation on the company’s board – three of the five board members belong to the Martin family (Gilles Martin himself, his brother Yves-Loïc Martin and their sister Valerie Hanote).