This report is published by Research Dynamics, an independent research boutique


On the road to a diversified industrial group

The overarching theme during the Investor Day at Perlen was CPH's successful journey towards becoming a geographically diversified industrial group from a Swiss-based European paper manufacturer. Higher demand for high-barrier film products (which drove the strong results in Packaging in 1H18) and lasting overcapacity in the paper market led to a strategic shift in the company's resource allocation from its Paper division to the Packaging and Chemical divisions over the past years. This is evident from the fact that Chemistry and Packaging together comprised 44% in 2017 sales (2013: 36%). Similarly, CPH continues to diversify its geographical footprint, improving its presence in non-European countries (22% in 2017 vs. 16% in 2013). This complements the group's strategy of maintaining its cost leadership by diversifying its production base away from the Swiss Franc (proportion of total costs in CHF: 36% in 2017 vs. 70% in 2013).
CPH enjoys leading market positions in its Packaging and Chemistry divisions (No.3 worldwide after KP Pentaplast and Bilcare for coated barrier films, and No.3 after UOP and CECA for molecular sieves according to CPH) on the back of recent acquisitions made by its autonomous brands Perlen and Zeochem, respectively. In addition to improving the group's EBITDA margin, CPH's expansion of its Packaging and Chemistry divisions is also reducing the group's exposure to the paper market and is helping it mitigate currency risks.

Packaging division: Multiple growth levers
Overall, the Packaging division recorded revenues of CHF 130 mn in 2017, accounting for 28% of the group's total revenues. During 1H18, the division's revenue grew at a buoyant 20% to CHF 79 mn. The EBITDA and EBIT increases were even more impressive at 51% and 76%, respectively, resulting in strong margins (EBITDA 16.1%, EBIT 12.3%). Thus, the investments of the past year are clearly starting to bear fruit. In Europe, the Packaging division witnessed full capacity utilisation, reflecting the strength in the market. Even outside of Europe, CPH' Packaging division should witness healthy growth in the coming years, given the various factors that work in its favour.

A strong end-market
Favourable demographic trends such as an aging population, ill-effects of urbanisation on human health and the consequent rise in lifestyle-related diseases are structural long-term drivers for the global pharmaceutical market. A strong end-market should ultimately benefit medical manufacturing, and thereby, pharmaceutical packaging. According to EvaluatePharma, the top 15 global pharma therapy categories are expected to grow at a CAGR of ~6.1% during 2015-2022 to reach USD 635.8bn. As a result, the global demand for pharmaceutical blister packs is expected to grow by 4-8% during 2016-21, with strong growth in high-barrier products (PVDC: 8-10%, PVC: 4-6%). These trends should support growth at CPH as the group intends to focus 90% of its Packaging in manufacturing primary packages for solid dosage forms and blister packs. In addition, CPH's presence in four of the top 20 pharma markets (as ranked by IMS) places it in a strong position to harness this growth.

Product innovation
CPH continues to strengthen its existing product offerings through ongoing focus on innovation, which is key to secure higher-margin products in this industry. The company has a history of continuously innovating its product portfolio; the BLISTair single-use powder inhaler under development being one of the most recent examples. As a result of its investments in innovation, the company's packaging solutions now cater to the needs of solid, liquid as well as powdered pharma products, expanding the range of its application.

Diversification into growth markets
While the USA represents the largest pharma market globally, it is not CPH's primary focus for international expansion. The reason is that North America is rather a "bottle" and not a blister market. Thus, the Packaging division is rather focusing on growth markets, targeting Latin America and Asia. As such, the rapidly-growing target markets of Latin America (CAGR of 5-8% during 2014-2019) and "Pharmerging*" markets (CAGR of 10-12% during 2014-2019) should still provide ample growth opportunities for blister packaging. With Brazil comprising almost half of the entire Latin American market, CPH has intensified its focus on the country, with the acquisition of 60% stake in Sekoya Indústria e Comércio Ltda. (Sekoya) in January 2018. Management said this acquisition has strengthened CPH's local distribution, as it enabled CPH to own a distribution company and a finishing plant in Latin America. This acquisition not only aids global diversification but also highlights CPH's risk-averse nature, as a bolt-on acquisition of a local dealer is more efficient (and probably less risky) than the setting up of a new factory altogether.
In Asia, CPH continues to strengthen its position in the key market of China. The company opened a new coatings plant in Wujiang (China) in 2Q16 and revamped it to better serve the Asian pharmaceuticals market. CPH's ramp-up initiatives have helped it build capacity in the market, and we expect CPH to see increasing utilisation as its efforts towards expanding its customer base bear fruit in the coming years.
Together with the division's presence in Europe (production facilities located in Switzerland and Germany) as well as in North America (Whippany, New Jersey), it is thus well positioned to becoming an even more important pillar of the overall Group, increasing its revenue share over time even further.

Outlook
For 2018 and beyond, CPH expects the strength in its Packaging and Chemistry divisions to more than offset the softness in the Paper division (given expected declining paper demand). Management expects the newly acquired businesses of Armar and Yusheng (Chemistry), Papierfabrik Utzenstorf (Paper) and Sekoya (Packaging) to have a positive impact on overall sales volume. CPH expects to report higher total net sales and earnings result for the full year 2018, assuming benign currencies.
For the medium term, management, on occasion of the investor day, reiterated its goal of achieving a yearly organic growth rate of 3%, an EBITDA-margin >10% (contributing a good basis for Cash Flow of around CHF 40-50 mn) and an equity ratio above 50%. Also, the group wants to maintain a liquidity position of CHF 30 - 50 mn which should give it enough flexibility to also go for opportunistic acquisitions, thus further rounding off its division's portfolios. On the capex side, the long-term average investment level is expected to be around CHF 15-20 mn. Lastly, but importantly, the Group targets to distribute a dividend of 30-50% of net profit, depending on the Free Cash Flow level.

Valuation and conclusion
We value CPH using DCF and relative valuation techniques. Our assumptions in the DCF valuation remain unchanged (market risk premium of 8.2%, beta of 0.9 and risk-free rate of 0.5%). Our intrinsic value of CHF 101.2 per share remains unchanged as well, implying an upside of 19.1% from current levels.
We continue to use three parameters (EV/EBITDA, P/S and P/E) to value CPH on a relative basis. We have retained the peer sets across CPH's individual businesses as well. As earlier, we first calculate the peer average of CPH's individual divisions and then take a weighted average of these based on the sales contribution of the respective division. Given its diversified business model, this consolidated peer average is most comparable to CPH's valuation multiples.
CPH currently trades at a P/S multiple of 1.0x (FY2018E), a significant 47% discount over the weighted average of division peers.
In the medium-term, we expect this discount to narrow and the stock to witness a revaluation, considering strong growth prospects in key markets, improved operating efficiencies from the new production facilities and benefits of continued business restructuring. The Paper division should benefit from its local market leadership, advanced technology and operational improvement, although it remains a challenging business environment with overcapacities and decreasing demand for newsprint paper.