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.