Recent Buy - Bayer AG (BAYRY)

I've had Bayer (BAYRY) on a watch list I have listing many companies that I would consider owning at reasonable valuations.  Those who follow the markets will know that Bayer has captured some headlines in recent years.  First, the company announced some time back that it would be acquiring Monsanto and the $63 billion transaction was completed in recently weeks.  However, just before the transaction was closed, the company found itself in the headlines again as result of California court awarding a plaintiff $289 million who had sued Monsanto, claiming that the company's herbicide had helped cause the plaintiff's cancer.  What's more, Bayer recently revised its guidance for 2018 downward by about (~7%), which results in a forward P/E multiple of 12.7 (resulting in an earnings yield of 7.87%).  With all this relatively bad news, one may think "what the heck are you doing investing your precious capital in this company?".  Well, in short, I think the long terms benefits greatly outweigh the near term risks.  I'll have additional commentary below, but before I get there, let's take a look at some of the basic metrics I typically review in consideration of a stock purchase.

Purchased: 50 shares x $20.784 (avg price) = $1,039.20 (+$0 commission)




Dividend Income: $43.07 ($0.8614/sh paid annually in May or Jun.)

P/E ratio: 12.7 Forward P/E (vs. S&P @ 24.5)

Debt to capital < 50%: Yes, 27.18%

Interest coverage ratio of at least 3:1: Yes, 7.46x (as of Mar 2018)

S&P and/or Moody's credit rating of BBB+/Baa1 or better: Yes, BBB+/Baa1

Current dividend yield > 1.5x S&P yield: Yes, 4.06% vs. S&P @ 1.8%

Payout ratio < 60% (or <85% for utilities): Yes, 51.6%

Dividend King or CCC classification: None.  However, per Bayer's own website, the company has paid dividends since 1952 and has increased the dividend annually since 2010.

Comments: It is worth noting here that Bayer AG (BAYRY) is domiciled in Germany and as a result, foreign tax is withheld from the annual dividend payment which can be claimed as a credit by US residents who itemize their deductions on their annual tax returns.  As such, ownership of this stock by US residents is better suited to be purchased and held in taxable brokerage accounts rather than in tax sheltered accounts such as Traditional or Roth IRAs.  Of course, one should consult with their tax advisor to assess their individual situation.

I have never purchased a stock based on any type of chart trend and I don't advocate doing so now.  I have provided the following chart simply to illustrate the recent plunge in Bayer's market CAP - YTD thru September 7th is (32%).



I addition, as I've been doing a bit of research on this stock, I've come to agree with comments recently penned by Morningstar analyst, Damien Conover, last month.  The following is an excerpt from this article:

"We believe the market has overreacted to the initial Aug. 10 court verdict regarding glyphosate. However, based on the high number of cases--close to 8,000 pending--and likely settlements in certain cases, we have increased our litigation-related charges by EUR 2 billion to be paid out over the next three years. This caused about 2% pressure to our fair value estimate, but we continue to view narrow-moat Bayer as undervalued.

We expect Bayer’s defense strategy, which management discussed in an Aug. 23 conference call, will follow the typical pattern seen in major drug litigation, where cases are litigated one by one over a long period, wearing down the defense with heavy scientific support showing that glyphosate-related products were not responsible for causing cancer. Further, we believe the Aug. 10 ruling, which awarded $289 million to a former groundskeeper with cancer, will be appealed and the final amount will be much lower. While nearly 8,000 cases remain, we believe most of them have low validity and are probably looking for any minor payment that might come with a potential class-action settlement. While precedent is not clear in this case, Bayer’s recent settlement over its birth control drugs, which worked through close to 10,000 claims, resulted in charges of around $2 billion.

For the Roundup product line, we don’t expect usage to fall off materially, and its contribution to overall profits is relatively minor. We estimate that glyphosate, the chemical used in the Roundup brand, would account for less than 10% of Bayer’s total sales and even less of Bayer’s profits. While Bayer does not break out glyphosate-specific sales, we believe glyphosate accounted for a low-single-digit percentage of Bayer’s profits, since it has been off patent for nearly two decades and margins are probably on the lower end of Bayer’s crop chemicals."

Now, if one is inclined to find the arguments presented by Morningstar to be valid and likely correct, does the 32% YTD decline in Bayer's market CAP seem justified?  I think not, but what say you?