Koninklijke DSM N.V. (AMS: DSM) is a Dutch company focusing on health, nutrition and materials, and has approximately 25,000 employees all over the world. The company has been a consistent performer, and continues to generate excellent financial results.

DSM1

Source: finanzen.net

The Q1 performance was satisfying

The company seems to be pleased with the start of its financial year, as it describes its own performance as ‘strong’. The total revenue increased by approximately 13% to 2.16B EUR, and it’s important to note approximately 9% was caused by organic growth, with currency fluctuations and ‘other’ parameters causing the remaining 4% increase.

DSM2

Source: financial statements

Indeed a great result - and the ‘good news show’ doesn’t stop at the top line. The EBITDA increased by almost 20% to 334M EUR for an EBITDA margin of 34%, which is substantially higher compared to the 14.16% in Q1 last year. The net profit came in at 148M EUR versus 84M EUR, and the shareholders will be very happy with an EPS of 0.84 EUR versus just 46 cents in the comparable quarter last year.

A lot of happy faces could be expected, especially when you see DSM’s cash flow statements are fully confirming the excellent performance on the income statement.

DSM3
Source: financial statements

The total amount of cash provided by operating activities was 196M EUR, but this included a 109M EUR investment in its working capital position, and excluded the full tax bill and interest bill. Taking these things into consideration, the adjusted operating cash flow would have been approximately 280M EUR (although the run-rate of the interest expenses will definitely be a bit higher throughout the year and this could have an impact of 25-30M EUR on a quarterly basis).

With a total capex bill of just 130M EUR, the adjusted free cash flow in Q1 was approximately 150M EUR which was spent on acquisitions (45M EUR), and share buybacks (26M EUR net of the proceeds from option exercises). The remainder of the cash flow was, as mentioned before, invested in its working capital position (the inventory level and trade receivables increased substantial).

This also means the company’s free cash flow is almost exactly in line with the net income, with a conversion rate of 101%.

Thermo Fisher wants to buy Patheon – the implications for DSM?

Earlier in May, Thermo Fisher (TMO) confirmed it had entered into an agreement to acquire Patheon (PTHN), a division which was recently spun off from DSM. DSM still is the largest shareholder and currently owns 33.5% of the total share count. As this is a minority interest, Patheon’s results and balance sheet are not consolidated on the DSM-level, and in Q1, Patheon contributed just 7M EUR to the net result. So DSM shareholders won’t feel the sale of Patheon.

Based on the ownership of 48.7 million shares and the offered price of $35/share, DSM stands to receive $1.7B which translates into 1.52B EUR at the current EUR/USD exchange rate of 1.12. This means DSM will see its cash position receive a substantial boost from the current 574M EUR to 2.1B EUR.

That’s important, because this will immediately reduce the leverage on DSM’s balance sheet. Whereas the official net debt position at the end of March was 2.84B EUR, this will now be reduced to 1.3B EUR by the end of this year when the sales transaction closes. Using an average cost of debt of 4%, we’re talking about potential interest savings of tens of millions of euros.

Investment thesis

DSM is on track to generate an adjusted free cash flow of in excess of 500M EUR this year, and this will help to reduce the leverage. However, the real key element will be the sale of DSM’s stake in Patheon, which could reduce the annual interest bill by 40-60M EUR, and immediately boost the free cash flow profile of DSM.

It will be interesting to see how DSM will spend its huge cash position on. Will it effectively reduce its gross debt position? Will it pay a dividend or initiate a share buyback? Or will it chase for other, smaller bolt-on acquisitions.

DSM is fairly valued right now as the company is trading at a free cash flow yield of approximately 5%, but it’s definitely one to add to your watch list to take advantage of weak days.

Disclosure: the author has no position in DSM, but could write put options during market weakness.

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