Blood products really don't get that much attention in the health care space, but it's a market worth more than $10 billion a year excluding hemophilia products and growing around 6% to 8% a year as indications and patient identification expand. Baxter (NYSE:BAX), one of the largest players in the market, is reasonably well-known to investors, but Grifols (NASDAQ:GRFS) is more obscure despite being one of the three largest players in the world and the largest in the U.S. As Grifols looks to leverage good underlying market growth through more efficient operations, the growth potential looks impressive.
A brief primer
The business of blood-derived proteins combines aspects of transplant medicine, biologicals, and even a little bit of refining. The entire business rests upon blood collection centers where companies like Baxter, Grifols, and Australia's CSL Limited (OTC:CSLLY) recruit regular donors who are paid (in the United States, at least) to donate whole blood on a regular schedule. This blood is screened and then processed (fractionated) to produce a variety of proteins including immunoglobulin, alpha 1 antitrypsin, albumin, and FVIII.
Like refining, the keys for success in blood protein production are securing reliable supplies of material (whole blood) at reasonable costs, maximizing the production yield, and balancing the fractionation (the "refining" process) to match demand for particular products.
In the case of Grifols, the company has some work to do in improving its process. The company's collection centers tend to be smaller and newer than those run by Baxter or CSL, and that has translated into a higher procurement cost due to fewer efficiencies of scale and a less well-established donor base. The company has also generally been around the middle of the pack in terms of production yield, but increasing the yield of IVIG (intravenous immunoglobulin) by just 5% would make a meaningful difference to profits.
An attractive, growing business
There are multiple characteristics that make the plasma derivatives market an attractive one for competitors like Baxter and Grifols. For starters, there are major barriers to entry – not only does the FDA oversee and inspect facilities (and grant approval for labeled indications), it takes a sizable collection network to be economically competitive.
It is also true that these products cannot be manufactured synthetically – there are some recombinant therapies available (Biogen's new long-acting hemophilia treatment Eloctate, for instance), but only in a few limited indications and they are typically more expensive (often by a significant margin).
Plasma derivatives are in many cases the only option for patients lacking important antibodies or proteins. IVIG, which is more than half the market, is used to treat conditions like primary immune deficiency, chronic inflammatory demyelinating polyneuropathy, and multifocal motor neuropathy, and it typically must be administered every few weeks. Although Grifols lacks a subcutaneous IVIG product to compete with Baxter's HyQ, the company nevertheless has leading share in the IVIG market, and roughly 60% share of the market for alpha 1 antitrypsin, used to tried a congenital form of COPD.
Multiple drivers are leading to consistent, significant market growth of around 6% to 8% a year. There is a limited pool of willing donors and a mismatch between the growth in demand from emerging markets and the supply of whole blood. It's also worth noting that many in the industry believe only about one-third of eligible patients are diagnosed and treated with these products; as indications expand and patient identification improves, so does the sales potential for Baxter, Grifols, and CSL.
Improving the business
Grifols become a top player in the plasma protein business when it acquired Talecris, combining two sub-scale players into a much more competitive company. Grifols also recently acquired the Novartis transfusion diagnostics business, which competes in the immunohematology (blood typing) space. This is a reasonably synergistic deal for Grifols, and it adds a little balance to the business (taking bioscience from about 90% of sales to 75%).
The key for Grifols now is to operate on a high level. Increasing volume through its collection centers should lower its procurement costs, while improving fractionation yields will likewise improve margins. Grifols could also be in position to benefit from impending capacity constraints at Baxter, as balancing production and collection capacity with demand is a challenging exercise in trade-offs (expand too much or too soon and excess capacity hurts margins; expand too late and sales growth is crimped).
Grifols should be able to generate revenue growth in the high single digits for the long term, while improving yields and costs leads to low-to-mid teens FCF growth. Those growth rates support a fair into the $40's on a discounted cash flow basis and also suggest that Grifols could generate attractive earnings growth over the next few years.
The bottom line
Investors should note that the Grifols ADRs are non-voting shares and the founding family still controls upwards of 30% of the voting power for the company. The non-voting shares get the compensation of a higher yield, but some investors may be bothered by that dual-class structure.
Grifols looks to be in an attractive spot – one of the top three players in a multibillion-dollar market with above-average growth and significant barriers to entry. While the shares may not appear so cheap on backwards-looking valuation metrics, the growth potential here argues that these shares have more room to run.