CEOInterviews.AICEOTalks met Rafael Padilla CEO van de maker van geneesmiddeleningrediënten Fagron.

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Interviewer0:08

Good afternoon, welcome to a new episode of CEO Talks. Our guest today is Rafael Padilla, CEO of Fagron, the maker of pharmacy ingredients. Also at the table is Frank de Mol, an analyst who will join the conversation and give his advice on the stock at the end. Welcome Frank, welcome Rafael. You can still ask questions directly via our website, but many of you have already done so in advance. As usual, we start with a very general question, Rafael: Can you explain what Fagron exactly does? Because we always talk about a supplier of pharmacy ingredients, but you are much more than that. Please explain.

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Rafael Padilla0:54

First of all, thank you very much for the invitation and for the hospitality. Fagron, as the name says, is pharmaceutical ingredients. As Ser mentioned, we started with ingredients for pharmacies in the Netherlands and Belgium, particularly. We have grown into a global company, present in almost all countries, delivering to more than 40 countries with offices worldwide. We have also grown with compounding itself, making the product for pharmacies, clinics, and hospitals. Besides compounding and ingredients, we supply machines, packaging, software, and testing, all specialized for personalized medication.

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Interviewer1:51

A question that often comes back. Sam asks: Mr. Padilla, how do you intend to create more shareholder value in the coming years? What are the biggest opportunities and dangers for Fagron? Reader Vermoen asks: what are your growth ambitions and how do you intend to achieve them? Nico also asks: what are the expectations for 2027 and the following years? All these questions center around the same theme: how will you create shareholder value and where do you want to grow?

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Rafael Padilla2:25

Very good questions for shareholders. What is extremely important for us is that our strategy, laid out during the Capital Markets Day in 2022, is being executed well. We focus on operational excellence to create value for our shareholders through better purchasing and production efficiency. Last year we directly or indirectly delivered 200 million scripts, so 200 million people received our product. Operational excellence is extremely important, along with a disciplined M&A strategy. We will discuss future plans, including 2027, at the Capital Markets Day in the second quarter.

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Interviewer3:30

I want to ask a follow-up. You set targets in 2022 for organic growth—you are on track or even slightly above. But on margins, you were aiming for 21.5% comparable EBITDA margin between 2021 and 2026, but you are below 20%. What are the prospects?

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Rafael Padilla3:57

Yes, our organic growth is slightly higher than then, which compensates a bit for the margin difference. What we also see is that the US, which has a lower margin, has grown more than other geographies, especially Europe. This means operational excellence is even more important. We handle more than 40,000 metric tons per day, so it is crucial to make that transition well. There is still room to increase efficiency and margins.

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Interviewer4:43

Exactly. Besides operational excellence, you also need to focus on sales and marketing. The demand for personalized medicine is increasing. Reader Fien asks: what is your unique selling proposition? What do you do that competitors don't? Filip Vermeire asks a similar question: what is Fagron's moat? In other words, how easily can competitors take market share?

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Rafael Padilla5:17

A very good question. The moat is that we have seen new competitors in all our geographies—EMEA, North and South America. Whether they have been successful, time will tell. What we do differently is that we are a global company, bringing together volumes and expertise, which is a huge competitive advantage. As Frank rightly said before the meeting, the fact that we invest heavily in quality sets us apart from the rest of the competition. Those two points are very important.

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Interviewer6:08

Now about quality. I assume there are questions about that. Erik asks: you received a warning letter from the FDA about your production facility in Wichita, USA. Were you surprised by that letter? Have you already taken measures? And do you believe in a good outcome?

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Rafael Padilla6:35

Yes, starting with the good outcome: we are convinced it will come. Everything the agency asked for is conceptually about raising quality standards. The GMP guidelines and USP monographs prescribe how to make products and what technical thresholds to meet. We comply well above those specifications. The FDA understands that the sector needs to raise quality levels, and they set requirements that may differ from the rules. We absolutely want to comply 100%. The warning letter is a mechanism the agency uses to communicate with companies to raise the quality of the entire sector. It was not just about us; all tier-one players in the industry have a warning letter. Were we surprised? We had the inspection in June, and it was the last day of the year, so a bit surprising in timing.

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Interviewer8:01

I thought your last press release said you had already addressed 60% of the requirements. You expected to be done by May. Are you on schedule?

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Rafael Padilla8:19

Yes, Frank, we are truly on schedule. In May we will be perfectly ready. We expect the FDA to come for their annual audit around May-June-July, and we will discuss it with the inspectors. We send monthly updates to the agency, which is required with a warning letter. Normally, a 483 observational letter is written first. We are complying with our monthly updates.

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Interviewer9:57

Reader Peter wants to know what your most comparable sector peers are on the stock exchange.

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Rafael Padilla10:04

That's a very good question, connecting to your first question about what Fagron does. The essential part is about 30-35% of our sales, which is specialty chemicals—you could compare that to a company like Amcd or Acis. We do a bit extra, repackaging goods in clean rooms. The brands part is about 20% of our revenue, which is pure development of our own products to make it easier for pharmacies—that would be like a developer such as Lonza. Then the compounding itself is about 40%, which would be like a pharma company, for example Hikma, a sterile manufacturer. So you can compare our segments to those.

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Interviewer11:10

Gary asks: what headwinds and tailwinds will impact growth in the coming years in the sector Fagron is active in, and what can you specifically do to protect margins?

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Rafael Padilla11:23

Good question. Headwinds would be competition. Many companies see our EBITDA margins and high cash conversion rates and think they can also enter the market. The underlying market grows at 6-7% year on year, so competitors want to come in. For example, we saw a large group like Kaldik enter Latin America. Another headwind is high regulatory demands, not just in the US but globally. If we are smart, we can use that as a tailwind. Tailwinds include the underlying market growth and our global footprint—we are the only one with a global footprint.

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Interviewer12:28

Reader Gerri notes that you are not present in Asia. Don't you see opportunities there?

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Rafael Padilla12:30

Good observation. The global market for personalized medicine is currently $14 billion, growing at 6-7% to $30 billion. Pharmaceutical compounding is about 1% of that. Looking at regions: North America, South America, EMEA, and Asia—Asia is about $2 billion. As a global player, we have an obligation to be there. We will share more at the Capital Markets Day. You will see acquisitions in that region. Our experience is that acquisitions are a bit better than greenfield. We would take small steps, as we have learned from the past that large steps involve risks.

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Interviewer13:41

Reader Bob de Smet wants to know about Brazil. After the acquisition of Injeplast, are there more opportunities in South America? And were you present at the Mercosur trade mission where pharma was central?

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Rafael Padilla14:05

That's a very good question. We received this question a lot. Unfortunately, we were not present at the mission. Our footprint in the region is large: we are in Brazil, Colombia, and Mexico, with Brazil making up 85% of the regional revenue. Injeplast gives us the opportunity to make our own packaging not only in Brazil but worldwide—backward integration. In Brazil, we have price pressure from competition, but we see that as an asset because it forces us to become more efficient. The efficiency of Fagron in Latin America is very high. We always say: sales growth like the US, gross margin like Europe, opex like Latin America—that combination makes us world champion.

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Interviewer15:25

Reader Pieter van Oven wants to know more about margins. He notes a shift to online pharmacies and larger pharmacy groups. Does that impact your margins?

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Rafael Padilla15:42

Yes, it's an online movement. We see platforms that doctors use to prescribe personalized medication, and that leads to compounding. That is a tailwind for our business model because compounding comes from online prescriptions. It's a way for doctors to differentiate themselves, and then patients go to the pharmacy. So not necessarily online pharmacies, but the platforms doctors use.

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Interviewer16:11

He also asks about products: do you see growth in starting with pre-filled syringes in Europe? Reader Carie asks a similar question: are personalized medicines gaining ground? And what is most important for you—supplying ingredients for pharmacies and hospitals or making the prescriptions yourself? Where do you see the greatest growth?

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Rafael Padilla16:43

An extremely important question. Our product offering is the same: you can buy the raw material, the finished product, or packaging. We are happy to help our customers with everything. But when the compounding is ordered, that is a bit better because it is more value-added. So we go a bit higher in the chain. We are very happy to help our customers with everything.

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Interviewer17:21

Reader Kerry asks: wouldn't it be better to divest one of the segments to specialize in just compounding?

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Rafael Padilla17:30

That question is asked often in our roadshows. Conceptually, Kerry has a point. But when you look at day-to-day operations, the raw materials and accessories are linked to how you make a medication. They give us enormous expertise to make compounding services extremely professional. So it's really linked, and it stays at Fagron.

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Interviewer18:08

Maybe another topic: the acquisitions you do. Reader Simona asks: you just acquired the Spanish company Guama. Are the valuations of that company higher or lower than Fagron's own valuation? And in general, what do you look for in acquisition targets? Is growth more important or valuation?

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Rafael Padilla18:41

Good question, Simona. Our multiples are between 6 and 9, depending on what we pay. Currently, we pay around 9 times EBITDA for this year. That is within our threshold. What we look for: first, a company focused on compounding and personalized medicine. We don't want other segments. Second, there must be a very good cultural match. Many acquisitions fail because of culture. Third, it must be additive to our strategy. As we said in 2022: first, market leadership in a specific market (e.g., Guama in Spain, Euro TC in Germany); second, new product offering (e.g., Injeplast in Brazil); third, new market (e.g., Parma Produkt in Hungary). We stick to that.

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Interviewer20:02

Nico Snoek asks: how do you ensure that the different acquisitions are well integrated into the Fagron model? What synergies are there?

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Rafael Padilla20:13

That is the question of the million. If we can do that well, we create enormous value for shareholders. We start with the culture element—culture is everything in a company. Then we integrate back-office, finance, systems, HR processes. Then we go for quick wins in P&L, especially on the purchasing side. For example, with Euro TC, 90% of the raw material is bought by the group cheaper. We can also benefit from that. Then we move to production and operational elements. You often see that we buy companies with margins below Fagron's, but within 18-24 months we bring them to Fagron's level, creating value.

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Interviewer21:13

I want to ask one more question. In 2023, you bought a company in South Africa active in veterinary compounding. I think that was your first in veterinary. What are your plans there? Do you see higher growth there than in the normal market for personalized medicine?

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Rafael Padilla21:45

That was a very good step in positioning. Veterinary compounding grows faster than human compounding. Human compounding grows at 6-7%, veterinary at 9-10%. We see it in all countries, including Belgium. Veterinarians prescribe personalized medication for animals. We supply the raw materials, and in the case of Wildlife in South Africa, also the finished product. It's a very interesting niche. Of the $14 billion market, about 8% is for animals. We plan to take more steps in that segment, in countries where compounding is allowed, like the US and Colombia.

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Interviewer22:58

A live question from Bob: what are the most important KPIs within Fagron, and how is your compensation package structured?

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Rafael Padilla23:10

We have a very professional board, led by Koen Hofman, that challenges us in a positive and constructive way. We have hard and soft KPIs. One specific KPI that is very important is the employee engagement score. We are at 87, compared to the global pharma norm of 84. That makes us extremely happy. The board also uses that for compensation. Other KPIs are sales, EBITDA, working capital, like other companies.

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Interviewer24:28

Reader Pieter asks: last year you booked a lot of revenue from semaglutide, an ingredient for the famous weight loss drugs. He asks if that revenue will continue. There was a shortage to produce it, but now maybe less. Do you expect revenue from that in the first half?

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Rafael Padilla25:00

Very good question. We have communicated that we will give guidance quarter by quarter for this specific product, which we never did. But it is very important. It generated about $6 million extra revenue in the past quarter. We will say in the earnings call in February whether we expect it in the second quarter. We have no visibility on very short-term orders. The FDA determines if it is available. Currently, on the FDA website, it is listed as a shortage, but the manufacturer says they have enough stock. The FDA wants to keep it as a shortage to ensure citizens get it. Novo Nordisk says there are still supply chain problems, so it may not be fully resolved. Eventually, when capacity is built, that extra revenue will likely disappear.

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Interviewer26:33

Reader Els asks if you expect to roll out new products. Are there other drug shortages you are benefiting from?

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Rafael Padilla26:53

Yes, definitely. The drivers of compounding are personalization and drug shortages, which grow year by year. In Belgium, the Netherlands, and France, even trivial products like amoxicillin have been on the shortage list. Compounding is extremely important for that. So shortages are a growth component for us.

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Interviewer27:32

Reader Christof Soens asks about artificial intelligence: how many AI agents are already active in Fagron's operations, and to what extent do you as CEO look at possibilities to increase efficiency with AI?

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Rafael Padilla27:48

Our CFO Karin and I have regular brainstorms on this. It's very important. We have a top-notch CFO who maintains discipline in our balance sheet. We are creating specific groups to work on AI, especially in operations, demand forecasting. We have a very large assortment, and these tools are extremely important to increase availability, which means efficiency and more sales. We also have a division, Tessen, that builds AI models to help doctors prescribe better. So on two fronts.

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Interviewer28:55

A live question from Dirk about M&A: is it a conscious choice to do smaller acquisitions because you learned from past mistakes? Have you drawn lessons?

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Rafael Padilla29:12

Yes, Frank said a few minutes ago: small steps. I'm sold on that, as the Americans say. Better to have a healthy balance and not take too many big risks. Fagron has become perhaps more risk-averse, but we take measured risks. We are entrepreneurial, we introduce new products, go to market with healthy aggressiveness, and take measured risks in capacity building. M&A is the cherry on the cake. We believe a company should show healthy organic growth with discipline, and then acquisitions are the top to make the cake nice. That reassures shareholders that we don't take too much risk with debt.

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Interviewer30:38

Your debt ratio has been steadily declining. You are now at about 1.5-1.6. Is there a certain level where you would become more active on the acquisition front, or maybe consider share buybacks?

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Rafael Padilla30:56

That's a very good point, Frank. We will talk more about capital allocation at the Capital Markets Day. Brownfield investment is our first priority. You saw that we built a large factory in Poland, and we have a new one in Brazil, our largest worldwide, built in 2022. We also have a new site in Tampa, USA. So that is growth for the next 10-15 years.

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Interviewer32:00

You invest about 3-3.5% of revenue annually, but now you are above that due to extra capacity investments. The maintenance capex is about 3.5%.

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Rafael Padilla32:11

Yes, maintenance capex is around 3.5%, that's our day-to-day. Brownfield is for us much better than an acquisition because we know the people, products, and market. There is demand, not own capacity.

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Interviewer32:33

Wim asks: we saw the factory in Brazil. What is the impact of the decline of the Brazilian real on the figures? He notes that it might be compensated by the rise of the dollar.

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Rafael Padilla32:45

That's correct. We are a heavily diversified company, historically with real ups and downs, which complicates with other regions and the dollar. We saw the impact in the semester and quarterly figures last year. You can calculate it neatly. Our factory in Brazil repackages our raw materials and does quality control for the US, which also helps financially.

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Interviewer33:23

Another topic with multiple questions: the new occupant of the White House, Donald Trump. Raf asks: what is the impact of the new Trump administration on Fagron, since you are strongly active in the US, your most important market? Pieter asks: you source raw materials from China and India to use in the US. What is the impact?

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Rafael Padilla33:52

Very good question. The tariffs on China: all our competitors source from the same suppliers. About 60% of our global purchases come from China. In the past, we adjusted prices, so little impact on our P&L. Products become a bit more expensive for consumers. Regarding the new administration, we think the new Health Secretary has said that prevention and lifestyle will become more important, and personalized medicine fits that. So that is a potential tailwind. Also, if the economy improves in the US, our products are paid out of pocket, so more capacity used. But it's too early to say.

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Interviewer35:07

Why is the dependency on China for raw materials so large? Is it because they are only available there, or because they are cheap?

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Rafael Padilla35:21

We have a Chinese hub in Fagron, together with our CEO Vera, who has helped us become more professional. We go to China regularly. It's impressive to see the factories the Chinese companies have built with high technology, AI, robotics, no humans in the equation, very high quality. For Western economies, it's not easy to compete. All pharma companies source a majority of APIs from there. If tariffs are applied, it's possible they are excluded. Currently, we have little visibility. In the past, tariffs were applied for a short period and then removed. India is an alternative to source more, as it is less in the spotlight. But specific products are centered in specific countries. For example, hormones are mainly made in China, antibiotics more in India.

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Interviewer36:58

Jan asks: how is the liquidity of your stock? There is often complaint that midcaps on the Brussels exchange are very difficult to trade. Are you satisfied with that?

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Rafael Padilla37:15

We discussed that this morning over coffee. Of course, we would like the stock to be more liquid. I speak not as CEO but as a shareholder myself. We need more exposure of the company, more outreach. As the company grows in EBITDA and revenue, it will come naturally. It's a very valid point.

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Interviewer37:47

Reader Steffen asks: could Fagron enjoy a higher valuation if it listed on Wall Street instead of Brussels?

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Rafael Padilla37:55

That could be. We receive reports from various banks saying that the multiples in our segment are about the same. We are very happy to be here in Belgium. We are not considering a move to Wall Street.

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Interviewer38:15

How about your shareholders? Colman Sax has a large stake, with NN Group. I assume that is a stable shareholder. But at the end of 2023, Klaus Reurich entered with OC Pharma. He is seen as an activist. What is his input? Are there certain points he wants to change?

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Rafael Padilla38:53

In this period, 'active' means active and nothing more. Less is more. Klaus is a participant on our board, which is extremely professional. We are very satisfied as management. He brings very good comments, especially on capital allocation. We had the case of Purna Farma, which we are now in competition clearance. Active ownership and Klaus and his team were active with different scenarios and integration processes. We are extremely happy with that. We have not seen activism.

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Interviewer39:37

David Duis asks: have you ever been in talks with private equity or approached by a potential acquirer for a delisting or privatization of the company?

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Rafael Padilla39:51

Normally, we receive contacts through the board, not through management. When the stock price was low, around 22, in Q3, we received some requests. But then the price recovered, so less interest. Currently, no takeover interest that I know of.

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Interviewer40:25

A live question from Patrick Vermeul: is Fagron a customer of Euro API, and to what extent do their problems impact you?

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Rafael Padilla40:41

I can say thank you to Patrick. We have hardly any business with Euro API, zero impact.

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Interviewer40:52

David also asks: do you have a specific strategy to get a higher valuation? What can you do specifically to increase the stock price?

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Rafael Padilla41:04

Good question. As CEO, I should not speak about valuation; the market determines that. We must continue to deliver what we have seen in the past year. That's one. Two, we said about liquidity: more exposure, more communication. Under the leadership of our CFO Karin, we have a new investor relations colleague, and with our sell-side analysts doing excellent work, we will get the mix right.

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Interviewer41:56

Steven asks: how sustainable is the dividend of Fagron?

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Rafael Padilla42:01

Good question. When I started in late 2017/early 2018, the board, under Chairman Koen Hofman, set a policy to gradually reward shareholders as the company performs well. In recent years, we have seen that, except for COVID, which was the only year we didn't follow that policy. But I think there is enough room. You estimate a dividend of 20 million or a bit more, and free cash flow is higher, so we can do both: gradually increase dividend and invest in growth.

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Interviewer42:52

Frank is very good, by the way. No question, but a comment from reader Dries: he wants to compliment you on your knowledge of Dutch. Thank you for this explanation. Maybe Frank, over to you. What do you think of the Fagron stock? Is it an interesting stock for the investor?

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Frank de Mol43:10

We wrote a recent analysis following the inspections and the subsequent decline. For me, that is a buying opportunity. Inspections are always reacted to heavily, but if you look at it from a distance, it's usually normal business that can occur. Looking at the valuation, about nine times EBITDA, there are no real comparable companies; you have to take a mix of different companies depending on the vertical integration. For a company that can probably achieve high single-digit growth for the coming years, and if margins can improve a bit, I think there is enough potential. You are one of the market leaders, globally active. So we are positive. We maintain a buy recommendation. Of course, if you can confirm those growth expectations at the Capital Markets Day, that would be a bonus.

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Interviewer44:52

I think we have covered most questions. Thank you very much, Rafael Padilla. Thank you, Frank de Mol. And thank you all for watching and listening. I'll check my screen. We are back on March 13 with Eve Kerstens from Beekart as our guest. I hope you all watch then. Until then, CEO Talks.

CEOTalks met Rafael Padilla CEO van de maker van geneesmiddeleningrediënten Fagron.

About Rafael Padilla