Coloplast

One of Denmark’s undisputedly best-managed companies, with a share price that has been challenged over the last few years. However, we do not think this is warranted, and find Coloplast to be a growth and earnings machine that keeps blazing ahead. A management team with a long-term focus, a great ability to innovate and growth opportunities in both East and West continue to make us happy shareholders.

In the short run, the stock market does not always reward the best long-term decisions, and in our view Coloplast exemplified this well in 2017. The share price development did not reflect how the company, strengthened its opportunities to gain market share and thus increase cash flows throughout the year.

Coloplast is the market leader on to the steadily growing and attractive markets for ostomy and continence. With revenue growth that has continually been greater than that of the market, the company is accruing market share every year, and with increased investments in sales, this should speed up from its current levels. The return on the invested capital in Coloplast is an impressively high 50 percent.

The operating margin at 32-33 percent in Coloplast is twice as high as it was in 2008, where there was a major change in management and CEO Lars Rasmussen took over. It is our assessment that Lars Rasmussen, with chairman of the board, Michael Pram Rasmussen, has been a major reason for this impressive improvement. 2017 has once again confirmed our belief in management’s strategic abilities and long-term perspective. In our view, this was reinforced by management’s decision to increase investments in sales-promoting activities.

When releasing figures for 2017, which ended in October 2017, the company revised their financial targets. Previously, these targets were to achieve an organic growth in sales of between seven and nine percent and annual increases to the profit margin between a half and one percentage point.

The sales target has been revised to be in the upper range of this interval, while the company has grown by seven percent over the last four years. It should be noted that this is not a bad performance in a market that is growing by around five percent. To achieve this target, the company will increase its investments by an equivalent to around one percent of revenue, and at the same time, they will be more active in looking for opportunities for small value creating acquisitions even if this might temporarily decrease the margins. This led to a revised target for the operating margin, with the target now being “over 30 percent”. Operating margin was 33 percent last fiscal year.

Taking advantage of competitors’ troubles

We have a positive view on the willingness to invest in creating more value instead of letting targeted margin improvements restrain value-creating investments. The opportunities for increasing sales due to an innovative market-leading product portfolio, in addition to problems facing the competition, has provided management with good reasons to seize these opportunities. The margins are not what drives value by itself, it is rather the value of the free cash flows that the company expects to create in the future. And when these cash flows will be positively impacted in the long term by these initiatives, the value should follow.

The majority of Coloplast’s customers are, unfortunately, suffering from chronic illness, and the primary function of Coloplast’s products is therefore to make it as easy as possible for the customers to go about their daily lives without facing difficulties. For Coloplast, this has a fortunate effect in that the demand for the company’s products is stable and very predictable. Coloplast is investing in the development of more user-friendly and better-looking solutions. The customers generally stick to one product as long as they do not have problems with it.

In the ostomy market, which is the largest business area with revenues of more than six billion Danish kroner, the greatest fear is that the ostomy bag will leak, and it would an irritation if the bag caused skin rashes. Making sure the product is user friendly is thus a focus area in Coloplast’s product development. The launch of the convex product, SensuraMio Convex, is a good example of this. The convex product form means that the bag will be less visible under the clothes. The convex ostomy bag has been successful in its first year and illustrates how this development can pay off.

The ostomy and continence care divisions are more than 75 percent of revenue in Coloplast, and in 2017, they were made up a larger share of growth. In terms of earnings, the two divisions have a higher share of earnings than revenues due to significant scale benefits with high incremental margins.

The wound and skincare division, which a fourteen percent share of the revenue, has a significant potential for growth in the United States and China. Among other things, this potential is to be exploited through increased investments in the American sales organisation, which has not previously had any noteworthy sales of wound care products. The profitability in wound and skin care products has significant potentials for improvement through scale benefits, and this is something we strongly believe that Coloplast can achieve under the current management of Nicolai Buhl Andersen.

The production costs are low compared to sales prices when it comes to wound care, and therefore it is essential to achieve critical mass as this is hugely important in relation to taking optimal advantage of the operational costs within this area.

Growth spurt in the United States

While Coloplast has a global market share of approximately 40 percent within ostomy care, the market share on the American market is around 15 percent. In order to grow this market share, Coloplast has, for a number of years, focused on their customer programme, Coloplast Care, where Coloplast enters into a direct dialogue with the users. Every third new ostomy patient has signed up for this customer programme, which is a good sign for Coloplast’s opportunities to gain market share. Management has previously stated that the goal is to increase the American market share by five percentage points to 20 percent in 2019, just as it grew from 10 to 15 percent from 2013-2016.

The Coloplast Care programme has been a way for the company to circumvent the group purchasing organizations that supply the American hospitals – where Coloplast is currently not included. We do note, however, that it has not been a stumbling block in the company’s efforts to increase its market share – and therefore we see no reason why it should not be a recipe for success in conquering further market shares.

The possibility of gaining market share, despite the lack of a presence in hospital contracts, is due to the fact that American hospital contracts do not limit the options for doctors and nurses to order other products from other producers. The system is therefore different from the tenders that one know from the Danish and many other European healthcare systems. It thus relies more on the presence of a skilled sales force that can visit doctors and nurses at the individual hospitals and convince them of the advantages of using Coloplast’s products. Hospital stays in the United States tend to be shorter than in Europe, which is due to the proportion of hospital costs that the patients have to pay for themselves. This means that product loyalty is not really established at the hospitals, but rather afterwards.

Here, the end-user’s choice of product is often influenced by what the individual distributors focus on. The patients have the freedom to choose and are therefore able to request another product than the one the distributor first suggests. This is one of the messages that Coloplast wishes to spread through Coloplast Care, where the patient can gain insight into why the products have more advantages compared to those of its competitors, and also inform them that they can request a Coloplast product instead of the distributor’s low-price product.

Coloplast acquired the American online distributor, Comfort Medical, in 2016 to gain more insight into the distributors. This acquisition has been a success for Coloplast, which has led to the acquiring of the French distribution company, Lilial, in December 2017. The primary focus is still on growing the existing business, and we are confident that management will allocate capital intelligently as they move forward, just as they have done in the past.

Market leading position in China

Since 2014, the executive board of Coloplast has consisted of four members. In addition to the CEO, this includes CFO Anders Lonning Skovgaard, Kristian Villumsen and Allan Rasmussen. Kristian Villumsen is the head of Coloplast’s chronic illness business, marketing and global R&D. Allan Rasmussen is the head of Coloplast’s global operations, with responsibility for the optimisation of the production, including moving the production to Hungary. This is aimed at lowering the unit costs. Previously the production started up in Denmark and then subsequently moved to Hungary once the processes were established, today, the production is initiated in Hungary. In our assessment, this will lead to a more effective working capital as it does not require the same level of inventory build-up ahead of the move.

While China in the previous fiscal year, 2016, had a negative impact on the revenue growth, significant investments have gained Coloplast a significant market share, especially in the ostomy and wound care market. The Chinese ostomy business contributed once more to sales growth in 2017, while the Chinese wound care business remains challenged. The market leading position in China is something we view as a very strong long-term asset for Coloplast.

Coloplast is financed conservatively, and thus, net debt amounts to only 0.2 years of operating income before depreciation and amortisation. The company only takes on debt in relation to business-related expansions, while distributions in terms of dividends and share buybacks are financed by the company’s continual generation of free cash flows. Dividends amounted to 15 Danish kroner per share in the most recent fiscal year, which was equivalent to a yield of approximately three percent. On top of that, there are share buybacks of 500 million Danish kroner, equivalent to a further half percent of the market value.

Since 2015, Coloplast’s urology business in the United States has been hit with lawsuits. It is expected that the settlements from these cases will cost approximately 5.3 billion Danish kroner, but further provisions are not expected. Management reports that more than 95 percent of known cases have been settled. The urology business is the smallest part of Coloplast, and thus only amounts to around ten percent of revenue. However, growth has been strong in the last few years, growing by almost ten percent through 2016 and 2017.

The main shareholder is the Louis-Hansen family who have the voting majority in the company. The Louis-Hansen family are descendants of Aage and Johanne Louis-Hansen, who founded Coloplast on the basis of the nurse Elise Sørensen’s ideas for an ostomy bag in 1954. Coloplast continues to help patients around the world live their lives as smoothly as possible – and we are confident that there is plenty of potential value in this market. We view having long-term patients in a profitable business model as an interesting long-term investment.