Chr. Hansen Holding AS: Wide Moat, But Management Has No Skin In The Game

This article contains some brief notes on Chr. Hansen Holding AS, the famous Danish enzymes, food/nutrition and natural colors company. The article is just a short presentation of the company and writing is kept to a minimum and mostly in the forms of bullet points.

The business and some history:

Chr. Hansen is a Danish company that supposedly touches about one billion of the global population every day. The company’s innovations date back to 1874 when Christian Hansen invented a process to extract rennet for cheese making. Other products have followed, especially after a diversification process in the 1970s when it was still a family-controlled company, and today the main products are used to expand food’s usable life spans (and preservation). The company does this by producing a wide range of “good” bacteria and microbial solutions to reduce antibiotics and pesticides and is today one of the world’s leading suppliers in cultures and enzymes to the food industry. The company has about 3 500 employees and turnover in 2019/20 was 1 161 million EUR. The primary listing is in Copenhagen and the ticker code is CHR.

Chr. Hansen was acquired by the French private equity firm PAI Partners in 2005 and subsequently delisted. PAI Partners “streamlined” the business and sold off the non-core businesses. In 2010 Chr. Hansen was again listed on the exchange in an IPO where PAI Partners sold most of its shares, and today they are completely out of the company. Since its IPO the share price has grown at a CAGR of 19%.

Currently, and for the last eight years, the business has been divided into three divisions:

• Food Cultures & Enzymes: this segment is the backbone of the company. The main products are within the segments cheese, fermented dairy products, meat and wine, where they have a market share usually in the 40s (%).
• Health & Nutrition: develops, produces and sells products within dietary supplements, over-the-counter pharmaceuticals, infant formula and animal feed industries.
• Natural Colors: develops, produces and sells natural color solutions to the food & beverage industry (mainly from fruits, vegetables, roots and seeds).

Cultures and Enzymes is by far the biggest division, and where they have the best market position (see more below). The natural colors segment works more on a “stand-alone” platform within the group and is potentially the most volatile as it depends on the most on commodity prices.

Their products help clients to:

• Differentiate products (flavor, texture).
• Increase productivity and yield.
• Extend shelf life and increase food safety.
• Substitute artificial ingredients.
• Promote health.
• It adds value to the client.

Unlike many other producers, Chr. Hansen’s products contain natural additives, not synthetic ones. The EU has implemented rules for labeling the use of synthetic colors, giving Chr. Hansen a boost (in the US the FDA is the regulator). Chr. Hansen is only producing the additive, so it’s the producer of the end-product that is responsible for the application process.

For a long description of Chr. Hansen and its IPO, this master thesis is a pretty good read.

Performance:

Since the IPO in 2010, the share price has risen 19% annually, while the earnings per share (EPS) has only risen 9%. This means a big part of the excellent performance is due to multiple expansion.

Revenue:

	Food
	cultures &		Health & nutrition		Natural
	enzymes	Growth %	nutrition	Growth %	colors	Growth %	Group	Growth %
13/14	464		133		158		755
14/15	519	11.85	165	24.06	175	10.76	895	18.53
15/16	565	8.86	184	11.52	200	14.29	969	8.32
16/17	618	9.38	225	22.28	220	10.00	1095	12.92
17/18	647	4.69	231	2.67	219	-0.45	1104	0.89
18/19	682	5.41	255	10.39	224	2.28	1177	6.56

The revenue is mainly from the EU and the US:

	EU
	Middle-East	North	Latin
	Africa	America	America	APAC
15/16	508	317	144	193
16/17	492	282	138	186
17/18	464	297	136	166
18/19	431	249	124	144

The exposure to emerging markets is a bit low, which I consider negative (emerging markets have much higher population growth).

This table shows the ROIC ex. goodwill (in %):

	Food
	cultures &		Health & nutrition		Natural		Group
	enzymes		nutrition		colors
13/14	34.6		42.7		26.2		34.9
14/15	40.3		42.2		17.4		37.6
15/16	46.2		30.6		25.8		39.7
16/17	47.1		29.8		30.3		40.1
17/18	45.6		29		24.6		38
18/19	44.2		29.5		24.2		37.3

Food & cultures is 68% of EBIT, Health & nutrition is 24% and Natural colors is 8%.

Mostly organic growth – not risky M&A:

Most of the growth is organic:

1. “Upselling” and innovation.
2. Extension into new food categories and adjacent businesses.
3. Market growth, pricing and market share.

For 2018/19 the organic growth was 7%: 5% from volume and mix (number 1 and 2 above), and 2% from price increases.

Is Chr. Hansen in a megatrend?

We can argue Chr. Hansen stands to gain from a “megatrend” in health and nutrition:

• Growing world population. However, most of the sales come from the EU and the US.
• Scientific evidence of health benefits from “good bacteria”.
• Chr. Hansen scores high on the sustainability index.
• The pressure to curb chemicals in crop production.
• Most likely more regulation, which limits competition, despite its intentions. Both regulations and trends among the population gravitate toward more healthy products.
• Morningstar expects the global food ingredient market to grow by close to 4%-5% CAGR over the following two decades, driven by increased penetration in the global food, beverage, and foodservice markets.

The moat  – competitive advantages:

Below I summarize what I believe are the reasons for their market position and strong organic growth:

• To my knowledge they spend more on R&D than their competitors: they innovate and know how to use that “intelligence” to fill the niches.
• Their niche markets resemble a monopoly/oligopoly – the customers don’t have many choices.
• Relatively high barriers to entry due to high R&D and technology.
• High added-value contribution to their clients’ final product.
• Long relationships with customers: the ten biggest customers have been there for over 25 years or more, which obviously leads to recurring revenue. Chr. Hansen typically spends a lot of time persuading a client to switch to them, but once done, the relationship tends to last for a long time.
• The technology installed by Chr. Hansen is custom-made for each customer. Very few customers want to tinker with their formula, thus making them stick to Chr. Hansen.
• The markets are not homogenous because the customers have certain preferences, which create loyalty from customers, thus high switching costs.
• Very few substitutes for cultures and enzymes.
• “Market intelligence” developed over decades which is hard to replicate.

All in all, Chr. Hansen seems to have a wide and sustainable moat that should generate profits in decades to come.

Capital Allocation:

Capital allocation is ranked like this in importance:

1. Reinvest for organic growth.
2. Bolt-on acquisitions.
3. Ordinary dividend.
4. Additional cash to shareholders (buybacks or special dividends).

40-60% of the net income is to be paid out as dividends, which usually receives no objections on the shareholder annual meeting. There is no explanation for why a dividend or why this percentage.

Management and skin in the game:

Inside ownership is insignificant, a big minus in my opinion (read here for why):

The board has in total 18 171 shares, worth only 9.6 million DKK (1.3 mill EUR). 5 of 11 members are “professional board members”.

The executives have 24 338 shares, worth only 12.9 DKK (1.7 million EUR).

Valuation:

Current TTM P/E is around 33, still a hefty premium to the market. However, the stock deserves a premium because of its moat, recurring revenue and sticky business, but I personally would not like to pay more than 25x earnings.

(This article was published on the 3rd of March 2020.)

Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.