Eurofins Scientific Investment Case

July 02, 2023
Ticker: ERF FP
Price: €58
Mkt Cap: €11.7bn
EV: €14.5bn
Eurofins is one of the world’s largest testing companies focusing on the Food, Environment, Pharmaceutical and Cosmetic sectors. Gilles Martin is the CEO and Chairman of Eurofins. He founded the company 36 years ago to provide wine authenticity testing. The tests involved using ground-breaking technology at that time called SNIF-NMR. That technology had been invented by his parents and their research teams at the University of Nantes six years earlier. It was the first time nuclear magnetic resonance (NMR) technology had been applied commercially for authenticity testing.

Mr Martin remains the company’s largest shareholder with a 32.8% stake.

Since its IPO in 1997, the company has increased its sales by 32% a year, on average, to reach €6.7bn in 2022, while its share price has compounded by c. 26%. Eurofins is a serial acquirer, with M&A being a critical driver in its growth strategy. The company has completed over 490 acquisitions. Its long-term objective for organic growth used to be 5%, but following consistent outperformance during 2010-21, management has raised its target to 6.5%, corresponding to the average organic growth rate during 2010-21.

Eurofins has benefited from the surge in demand for COVID testing in 2020-2021, which contributed €0.8bn, €1.4bn and €0.6bn to its revenue in 2020, ’21 and ’22, respectively. As a result, its performance in 2022 and forward guidance looks unimpressive.

Revenue in 2022 was flat at €6.7bn, while EBITDA declined by 20% YoY to €1.5bn. EBITDA margin dropped from 28.3% in 2021 to 22.5% in 2022.

As expectations have been coming down, the company’s share price has also corrected. It is now down -13% YTD and down -54% from its all-time high price reached in September 2021.

However, the business has continued to grow (by 5.8% in 2022, excluding COVID-related revenue). Going forward, Eurofins targets organic growth of 6.5% and overall revenue to reach close to €10bn by 2027 (with c. €250mn annual contribution from M&A). Its 2027 goals also include a 24% EBITDA margin and close to €1.5bn FCF (twice compared to its 2023 target of €700-750mn).
The past track record and strong alignment of interests between minority shareholders and the founder / CEO are the two points that attracted me to Eurofins. But there is more:

  • There are secular demand drivers such as improving living standards globally, the rising share of the older generation, demand for safe and environmentally friendly products.

  • The sector is still highly fragmented.

  • High barriers, including R&D and customer trust, limit competition.

  • Customers prefer to work with reliable suppliers and want to avoid taking the risk of going with a new provider, given potential negative consequences. As a result, established laboratories enjoy high recurring revenue.

  • Customers are not price sensitive. The cost of a test is marginal compared to their overall cost structure. But getting the necessary certificate and approval is critical for the overall success of their business. Hence, companies like Eurofins enjoy strong pricing power.

  • Testing companies also enjoy scale effects as specialised laboratories operating under one brand are more valuable to customers who prefer one-stop solutions rather than dealing with individual providers. Stand-alone laboratories have high fixed costs, so additional revenue that comes from cross-selling goes right into the bottom line.

The only main issue that stops me from buying Eurofins shares is valuation. While the stock is down a lot, it is still priced at about 5.4% FCF yield. FCF number does not take into account the capex that the company spends on upgrading its sites. The net FCF is also lower because of M&A spending by the company, which generates about 70% of the company’s overall growth. The company’s share count has also been rising over time (+38% since 2008).

If the company’s business model is somewhat similar to Amazon or Costco (“scaled economy shared”), then applying traditional metrics like PE or FCF yield to value Eurofins would be wrong. I plan to spend more time understanding Eurofins’ business model and its competitive advantages before making the final decision.
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