Hi reader,
Welcome to the second part of the article series of the latest addition to my portfolio. In the first part I shared a brief investment thesis on this company, here it is:
The company operates in an oligopolistic industry made up of rational players (three competitors have recently signed an “alliance” to take their products to market).
The company’s products make up a low portion of their customers’ costs and are mission-critical. They are also protected by regulatory barriers.
The industry is expected to grow significantly over the coming years, with a good portion of this growth coming from higher-margin sources.
It’s family-owned and operated (third generation), and management exhibits clear traits of long-term thinking.
The company’s compensation structure is based on ROIC and organic growth, which is not a coincidence considering they aim to replicate winning formula of its main competitor aided by non-other than its former CEO (who serves on the board)
The company is currently undergoing a significant Capex plan to prepare for future growth, but the capacity expansion is demand-driven and based on multiyear agreements with customers (so there’s high visibility).
The stock is currently swamped with opportunity costs because it’s facing several temporary headwinds (besides the capacity expansion plan). I must add that despite an almost $6 billion market cap, it’s pretty much out of reach for many funds due to its tiny float (the family still owns a considerable chunk of the company).
In that article I went over the company’s history and what it does. In today’s article I’ll explain its financials and growth drivers, which are pretty important topics because both are “masked” behind the current situation. In subsequent parts I will go over…
The Competition, the Moat, and the risks
Management & Incentives, Capital Allocation, and Valuation
How it complies with the Best Anchor Stock traits
Without further ado, let’s jump right into the financials and KPIs.
The financials and KPIs
We do not have 10 years of financial history for Stevanato because the company IPOed in 2021 (this is also one of the risks). We do have numbers up until 2019, so I will base this section on those. As always, I’ll review the company’s three most important financial statements: the income and cash flow statements and the balance sheet. You’ll see that the three are pretty much intertwined and reflect Stevanato’s current situation.
The income statement
Stevanato has grown its revenue at a fast pace since 2019, and we know most (if not all) of this growth has been purely organic because it has not conducted significant acquisitions since 2016:
It’s important to look at the performance of the different operating segments to contextualize this growth. First, I should note that overall revenue growth was definitely aided by pandemic tailwinds in two ways…
The COVID vaccine brought significant volumes to the company (as it was an injectable)
Customers were afraid of running out of inventory and therefore ordered ahead of demand, creating stocking (which is now normalizing)
While the second of such tailwinds has come back biting the company in the form of destocking and is one of the reasons behind the current slowdown, the first tailwind (COVID) is now completely behind the company and has been replaced by other treatments (like GLP-1s). This demonstrates that Stevanato is not really exposed to any given therapy like a pharma company could be (this is what makes the picks and shovel companies attractive, among other things).
The company has two reportable segments (if you don’t know or don’t remember what these are, be sure to check the first article):
Biopharmaceutical & Diagnostics Solutions (aka. BDS)
Engineering
BDS makes up 81% of Stevanato’s revenue, so its growth rate is much more tied to overall company growth. In the chart below you can see how it has evolved similarly to overall revenue growth:
Engineering makes up a smaller portion of revenue, but as discussed in the first article, it’s also essential in terms of competitive advantages and future growth opportunities. The Engineering segment enjoyed very significant growth in 2020, 2021 and 2022, far above what should be considered sustainable:
This has also come biting the company back through operational issues. There was huge demand for Stevanato’s engineering products during the pandemic, which coincided with supply chain issues that made the backlog grow significantly ahead of what the company could cope with. Management is doing several things to sort these issues out. They…
Hired a Chief Operating Officer
Announced plans to run through the backlog before selling any new business
The second one is creating short to medium-term growth headwinds, whereas the first is more oriented towards profitability (both are related).
These can be understood as the underlying segments, but we can further differentiate the company’s financials into different “sub-segments,” of which I would highlight the following: High-Value Products and recurring revenue. Let’s start with the former: High-Value Products.
As discussed in the first article, Stevanato is currently undergoing a shift from bulk products to high-value products. These products are confined to the BDS segment, making up 34% of total revenue and 42% of BDS revenue in 2023. The transition has been ongoing for some time and is expected to continue (I’ll discuss why more in detail in the growth section):
Management attributed the current destocking issues to bulk vials (where Stevanato is a leader). This seems credible considering that HVPs continue to grow ahead of overall and BDS revenue growth:
In the second quarter of 2024, revenue from the BDS Segment grew 9% to €222.4 million (9% on a constant currency basis), compared with the same period last year. Revenue from high-value solutions increased 23% to €103.4 million, while revenue from other containment and delivery solutions declined 1% to €119.0 million, compared with the same period last year.
In my opinion, this development is core to the investment thesis because HVPs continuing to grow ahead of bulk products confirms the ongoing shift and strengthens the profitability case. Recall that high-value products enjoy around 40%-70% gross margins, or roughly double those of bulk products (15%-35%). I’ll share later an exercise to show how this transition can positively impact margins.
Another topic worth mentioning is that of recurring and non-recurring revenue. I would consider consumables (pretty much the entirety of BDS) somewhat recurring revenue, and William Blair agrees here, giving Stevanato 81% of consumables revenue:
However, I would argue that recurring revenue is somewhat higher due to the parts and services division within Engineering. We don’t know what percentage of overall engineering revenue comes from such sources, but management claims they are actively working on growing it. What I call here “recurring revenue” is not really recurring in the “SaaS” (Software as a Service) sense, but it’s repeatable and pretty resilient revenue nonetheless.
All things said, it has undoubtedly been quite a lumpy ride regarding revenue growth, and we don’t have a very long financial history to mute this lumpiness. However, after understanding its puts and takes, it's easy to see a company that can potentially grow its top line double digits in a normalized state. This is, uncoincidentally, what management targets over the long term and what most businesses in the industry expect. Note that West’s 10-year revenue CAGR stands above 8% despite them being far ahead in the transition to HVPs:
Things get even noisier on the profitability front. The reason is that all the “noise” included in the top line drops through to the bottom line in the form of inefficiencies. Such inefficiencies come from destocking (i.e., not operating at full capacity) and operational issues in the engineering segment. Stevanato follows a fixed-cost business model where utilization matters dearly (somewhat similar to Texas Instruments, although not to the same degree). This means that when utilization decreases, so do margins.
Management can somewhat leverage operational expenses, but they are typically reluctant to lower R&D expenses because these drive the business long-term. As you can see in the graph below, the company has achieved some kind of leverage on SG&A, but R&D has remained somewhat constant as a percentage of revenue:
If you are wondering why SG&A's percentage of revenue was so high in 2019 and 2020, that has to do with expenses related to the company’s IPO.
I’d say it wouldn’t be a surprise to see some kind of SG&A leverage in the future as the transition to HVPs continues. The reason is that such products carry a significantly higher ASP (Average Selling Price) and higher gross margins while not demanding significantly greater SG&A expenses (more so considering that a good portion of it is “replacement” revenue). I doubt, however, that we’ll see much R&D leverage, considering that it drives future growth.
To the “underutilization” situation impacting both segments we must add inefficiencies related to the current capacity expansion plan. Stevanato IPOed with the only objective of using the proceeds to invest in capacity to capture future growth. There are certain inefficiencies related to such capacity expansion plans, most of which are bundled under start-up costs, which consider the underutilization of such plants and their opening costs.
Start-up costs are evidently non-recurring, so management discounts them from Adjusted EBITDA. We should always be careful with adjusted metrics, but this adjustment makes sense. Start-up costs amounted to €12 million in 2023, which is not extremely significant in the grand scheme of things but lowered total EBITDA by around 5%.
The company’s adjusted EBITDA margin barely budged from 2022 to 2023 despite HVPs going from 36.7% to 41.7% of total revenue, signalling that underlying profitability is currently being masked by the two inefficiencies I discussed above. The difference between the adjusted EBITDA and non-adjusted EBITDA margins you see below purely come from capacity expansion inefficiencies and it’s natural to see the gap increase as Capex increases:
Then we have two additional impacts before the bottom line:
Higher interest costs
Higher depreciation
Management argued that their growth expectations from IPO are higher now, so they’ve conducted several debt offerings through these years to continue investing in capacity. Higher debt has obviously resulted in higher interest costs. I wouldn’t consider interest costs non-recurring because Stevanato is not a levered company and is likely to operate with this modest leverage going forward.
Higher depreciation is related to the current capacity expansion plan and has been growing ahead of revenue for some time:
Note that D&A could be seen as a proxy for maintenance Capex. Management argues that their maintenance Capex stands at around 3% of sales. D&A expenses are currently running at 7% of sales, meaning they are likely to be elevated through this capacity expansion period. This is the reason why (for the time being) I prefer to look at Stevanato on an EV/EBITDA basis.
With all this said, let’s look at the company’s current margins, which I hope is clear by now that they are not normalized. Despite this abnormal environment, Stevanato boasts great profitability, reporting net profit margins in the double digits despite all the headwinds:
With all the margin headwinds behind us (at some point) and a continuing transition toward HVPs, we should see these margins reclaim their prior high and trend upwards from there. Note that a recovery to ATHs would already translate into a 460 bps expansion to the bottom line. Higher margins should also be considered a “requirement” considering that Stevanato is now more capital intensive than it probably was before making the transition to HVPs.
Another topic I think is interesting to unpack here is the impact the transition to HVPs can have on margins. It’s a very tough and opaque exercise because the segment is currently going through bulk vial destocking and margins can vary within the HVP segment, but we can give it a go.
Management claims that the gross margins from HVPs are typically around 40-70%, with that of bulk products being around half (15% to 35%). I’ll take the midpoint of both at 55% and 25%, respectively.
Assuming those midpoints, every 1% increase in HVPs as a percent of overall BDS should translate into a 30 bps expansion of the segment’s gross margin. The math here is straightforward. If BDS revenue were to be distributed evenly between HVPs and bulk, the gross margin (assuming the midpoint) would be 40%. If the proportion where to change to 51% HVPs and 49% bulk, then the gross margin would be 40.3% (51% * 55% + 49% * 25%). Assuming BDS remains at 81% of overall revenue (and that nothing changes from a margin standpoint in engineering), this 30 bps would translate into 24 bps increase to overall gross margin.
So, say that HVPs go from the current 41.7% of total BDS revenue today to 45.7% in five years (which seems conservative). Under this scenario we should expect around 120 bps of gross margin expansion in BDS through the period (again, using the midpoint here) and a 97 basis points expansion to the consolidated gross margin. This margin expansion would mostly come from replacement demand, and I say it’s highly likely because management expects 42.5% of total revenue to come from HVPs in 2025, which would equate to around 52%+ of BDS revenue (currently 42%). If this transition were to take place as management expects it to and everything else stays the same, this should equate to a 300 basis points gross margin improvement in the BDS gross margin over the next 3 years.
Again, don’t take these numbers at face value because there are many unknowns. I was just trying to show how the transition to HVPs is highly accretive to margins.
The cash flow statement
Stevanato’s cash flow statement is currently a bit of a mess for two main reasons…
All of what I discussed above negatively impacts the Operating Cash Flow
The company’s capacity expansion plan is currently weighing heavily on Free Cash Flow
Both reasons have caused Free Cash Flow to be in deeply negative territory, so Stevanato has “survived” through three sources:
The capital from the IPO
Several share issuances
Several debt issuances
Note that Stevanato IPOed with a specific capacity expansion plan in mind, but growth expectations were above what they had initially planned so they ended up investing more than expected into capacity:
One of the things the market might be worried about is an additional stock/debt issuance. Cash flow is somewhat normalizing thanks to improved cash conversion, but Stevanato has burned through €75 million during the first 6 months of the year, and there are roughly €80 million in cash and equivalents left on the balance sheet. Liquidity is definitely going to be tight, and if it ends up falling short, management has mentioned they would probably opt for debt (rather than stock) issuance. This makes quite a sense, considering that the family remains the majority owner and more stock issuances would dilute their ownership.
Capex is what stands out from the company’s cash flow statements. Stevanato is a business with maintenance Capex of around 3% of sales, but Capex has been running north of 30% of sales for a while now. Management has argued that “north of 90%” of such Capex is growth Capex, which would be consistent with maintenance Capex being somewhere around 3-4% of sales:
Stevanato believes that 2023 was “peak Capex,” something that seems believable considering that LTM (Last Twelve Months) Capex is decreasing. Capex is expected to decrease gradually until reaching 10% of sales around 2027. 10% of sales is still significant Capex intensity, but they argue that it would constitute 70% growth Capex (again, consistent with 3% of sales being maintenance Capex) and that it should help sustain low double-digit revenue growth (and arguably faster net income growth as the transition to HVPs continues). I’ll talk about Capex in more detail in my article on capital allocation.
Free Cash Flow will take some time to normalize due to all the headwinds discussed above, but what we should care about is owner earnings (i.e., how much cash is left for shareholders at a steady state). Management expects to convert EBITDA at a 40% rate (midpoint) to Free Cash Flow in 2027; I imagine this assumes that Capex remains at 10% of revenue.
Assuming €435 million in Adjusted EBITDA in 2027, Free Cash Flow would theoretically come somewhere around €175 million ($190 million). This would be the level of cash flow consistent with Capex of around €145 million. The owner earnings calculation is used to calculate how much would be left for shareholders if only the investments necessary to maintain the business were to be made, which would be (as discussed earlier) around 3% of sales. This would bring owner earnings to around €277 million ($300 million). This means that the 2027 owner earnings yield is currently around 6%, definitely not extremely cheap, but the business would still be able to grow around 3% from then on. Of course, I am banking on faster and more durable growth from 2027 onwards.
The balance sheet
I’ve touched on the balance sheet a bit above, but I’ll add more color here. Stevanato has issued debt and stock to conduct the current capacity expansion plan. With €80 million left on the balance sheet and a YTD cash burn of €75 million, a future debt or stock issuance (probably the former) is not off the table. However, this should not be worrying because Stevanato is in a good financial position.
First, its net debt to EBITDA ratio stands below 1, and this is with fairly depressed levels of EBITDA:
Secondly, the company operates in a resilient industry where it’s tough to see significant bumps along the road. Stevanato has a short financial history (and so do many of its peers), but we can look at West’s performance over the years. West remained solidly profitable even through the GFC:
Despite all the current headwinds, Stevanato boasts an 11% net income margin and a 13% operating cash flow margin, so it’s definitely a profitable business even through bad times.
Thirdly, the company’s Capex approach is modular, meaning that it can pull back on it whenever it is necessary. For all these reasons, I’d say that Stevanato’s financial position is strong and should get stronger as the Capacity expansion plan gets behind us. This is a family-owned business, so I highly doubt high leverage will ever be a problem.
The Growth Drivers
As I mentioned in the first article, Danaher and Stevanato participate in different steps of the same value chain, so they are exposed to similar growth drivers to an extent. The growth driver that both have in common is the rise of biologics medicines, although it impacts both companies differently. Through its Biotechnology Segment, Danaher provides the tools and consumables to manufacture biologics, regardless of how these will be administered to the patient. Stevanato, through its BDS segment, provides containment solutions and delivery devices for injectable drugs. This is where we can find the main difference: a biologic doesn’t necessarily have to be an injectable, although they typically are due to their sensitivity. According to several doctors I’ve spoken to, a biologic “needs” to be an injectable because the digestion process could potentially destroy the protein, significantly lowering their efficiency.
The rise of biologics (also referred to as “large molecules”) is pretty evident when we look at the data. These types of drugs are gaining prevalence because they are effective in treating diseases that small molecules have historically not been able to (think about Alzheimer’s, cancer…).
According to IQVIA, spending on biologics has been growing significantly faster than other therapy types, and they now comprise around 46% of all spending. The image below also portrays what I have just discussed: biologics are prevalent in diseases that have historically remained poorly covered by non-biologics:

The pipeline is no different and is also “filled” with biologics. Obviously, not all of the biologics in the pipeline will make it to market (only a few will), but the pipeline’s composition is a good leading indicator of the drugs that might come to market in the future.
In terms of injectables, Stevanato (based on a third-party study) claims that 61% of the 21k drugs under development are currently injectables. Not only are they more significant in number but they are also (typically) higher value than non-injectables.
Many people are worried about biologics due to their cost and claim that the growth of spending on biologics should moderate once biosimilars arrive to the market. Biosimilars are non-patented biologics and come to life once a biologic is off-patent. According to IQVIA, the price of biologic medicines tends to decrease considerably after a biosimilar has been launched:
Stevanato should, in theory, benefit massively from the arrival of biosimilars as these should bring more volume to the market thanks to increased affordability; it’s volume that Stevanato cares about. There are also fears about the kind of containment solution a biosimilar would use due to their (supposedly) lower price. Some people believe this might lead to downgrading, but Stevanato (and the industry) thinks differently:
The fact that we are already registered in the originator will help us to give a very strong reference both in product and service and processes. Biosimilars tend to copy the type of drug packaging that the originator has in terms of performances and in terms of specification.
Time is money in this industry, and changing the packaging solution would require more regulatory steps and development time. It makes sense for the biosimilar to adopt the primary packaging solution of the biologic considering it makes a low portion of the total cost of the drug, and getting it to market early can substantially cover those higher costs.
Regulation is also expected to be a tailwind for the industry. The regulatory framework around primary containment is getting more stringent, “forcing” pharma companies to demand high-value solutions that provide safer interactions with the drug. Note that evolving regulation around primary containment (like Annex 1 recently released in Europe) leaves pharma companies with two options…
In-source operations and adapt to the changing regulatory environment. Expensive in both money and time
Outsource these tasks to other companies so that adapting to such regulations becomes almost “automatic”
Many pharma companies are opting for number 2, although it comes with higher Opex from the increased price of high-value products. This evolving (and stricter) regulatory landscape should serve as a tailwind for high-value product growth. The fill and finish lines need to be adapted to process high-value products, meaning that the transition is expected to be sticky because it requires a Capex investment from the customer (either the pharma company or the CDMO):
The number of fill and finish lines capable of processing sterilized vials and cartridges is estimated to have increased 32% in 2023.
As discussed throughout this article, much of this demand for high-value products will probably from replacement demand rather than new demand per se. Stevanato argues that around 70% of current growth is coming from existing customers rather than new customers, something which probably gives credibility and resilience to such growth:
For what concerns the 70%, I mean, it’s a relationship that is consolidated in place since a long time and we see this as an evolution of the existing customer relationship. The consolidated relationship with key accounts are all covered with multiyear agreements.
All that I have discussed above should theoretically lead to higher revenue growth, which should be amplified to the bottom line as HVPs take over bulk products. As discussed above, these products are roughly double the gross margin and can carry up to a 10x increase in ASP (Average Selling Price).
M&A could also be another source of growth, but management has pointed out that they are not actively looking for any targets as they already have an E2E solution (which was built through M&A before becoming a public company).
Regarding the engineering segment, there are several growth drivers. First, the fact that there needs to be a capital investment in the fill and finish lines to adapt to high-value products is beneficial for this segment. Secondly, the growth in self-administration might also lead to higher demand for assembly and packaging equipment, both of which Stevanato provides. Lastly, the increased outsourcing by pharma companies will lead to higher (one could call it inefficient) Capex from customers.
The macro drivers: AI and an aging population
I would also like to briefly discuss two “macro” growth drivers common to the pharma industry (not just fill and finish). The first one is well-known: an increasingly aged population. People live longer and natality is shrinking (at least in developed economies), giving rise to an older population. Older people are more prone to diseases, and therefore they require more medicines.
The second macro driver, which honestly has made me focus on the picks and shovels of the healthcare industry, is AI (Artificial Intelligence). Many people are still wondering where AI will have the most significant impact, and while I don’t know if it’ll have the most significant impact on drug discovery, it sure promises to have a significant one.
According to several studies, AI should decrease the cost of drug discovery, allowing pharma companies to take on more projects with the same funds. Reduced costs should, in theory, come from AI helping save significant time in the process. According to this OECD report, AI could result in up to 20% savings throughout the drug discovery process:
This should technically lead to the discovery of more drugs and therefore to more volume for the picks and shovels of the industry.
Of course, on the other side of the coin, one has to understand potential disruption risks. However, as these companies often enjoy strong regulatory entry barriers, it’s tough to envision a scenario where AI poses a significant threat to their business models (although we should never say never). Stevanato’s success is not the product as such but rather its reputation together with the historical conservativeness of pharma companies.
For this reason, I believe the picks and shovels of drug manufacturing enjoy an asymmetric opportunity from AI.
In the meantime, keep growing!
Read part 3 here 👇🏻