Bayer Risk, Reward Balanced

Bayer AG (BAYRY) has been shifting its focus on the healthcare segment in the past few years in order to maintain solid growth in the long run. The acquisition of Schering AG should improve its product portfolio, and we expect higher-cost synergies from the acquisition. The company reported 2Q08 financial results which were in line with our expectations. We maintain our Hold rating.

Bayer’s future growth should be mainly driven by its healthcare segment. However, we are concerned about the slowdown in this segment, especially in the fourth quarter of 2007 and in the first quarter of 2008. Sales in the healthcare segment only grew by 0.9% in 4Q07 and 3.4% in 1Q08.

The failure of Nexavar for lung cancer and the U.S. court ruling against Yasmin will have negative impact for the growth of the segment. Therefore, we are lowering our estimates for 2008 and beyond.

The CropScience and Material Science segments should stabilize in the coming quarters.  Currently, Bayer stock is trading at 11.7x our 2009 EPS estimate of $6.71 per ADR. Based on the business outlook we mentioned above, we believe the risk/reward profile is balance for Bayer stocks.

Using our fiscal year 2009 earnings estimate of $6.71 per share, and a forward multiple of 15x, discounted at 20% for one year, we arrive at our price target of $85. The P/E ratio of 15 is between big pharma industry P/E of 18.6 and chemical industry P/E of 13.6. We choose this hybrid P/E because Bay operates in these two industries and each segment accounts for about 50% of its total revenue.

Read the full analyst report on BAYRY

Read the full analyst report on BAYRY