A stroke of Genus?

The global population is expected to reach 8.5bn by 2030, up from 7.8bn today. More people means more mouths to feed. And while much has been made in recent times of an accelerating shift towards vegetarianism and plant-based living, animal protein isn’t going anywhere fast. Indeed, pork, milk and beef consumption are projected to rise 1 to 2 per cent each year over the next decade.

But such growth presents a challenge in a world that is struggling to respond to climate change and calls for sustainable food production. Particularly while the staple agricultural resources of land and water are in increasingly short supply.

Farmers must therefore be smarter and more efficient about livestock breeding in order to maximise the quality of their herds. Simultaneously, greater awareness among consumers about the contents of what we eat has driven an aversion to artificial ‘nasties’ or drugs that might have been used historically to fend off infections.

It is for those reasons that Genus (GNS) works with some of the world’s largest meat and dairy companies. The FTSE 250-listed animal health group, which serves more than 50,000 customers in over 75 countries, specialises in genetic improvement. Its proprietary scientific technology allows farmers to raise healthier and more productive food-producing animals, helping them to stand out against an ever-more competitive backdrop.

Underpinned by a leading market position and robust barriers to entry, the group has enjoyed rising demand for its wares. This has translated into a compound annual revenue growth rate (CAGR) of 9 per cent over its past four financial years, reaching £551m in July 2020. Adjusted pre-tax profits improved at a similar pace to £71m.

Genus’s shares have in turn performed extremely well, climbing more than a half since last March; no mean feat during a period characterised by pandemic-induced uncertainty. Small wonder, perhaps, that the group is the top holding in Baillie Gifford’s UK Growth equity fund. As reflected in Investors’ Chronicle’s Ideas Farm last week, it is also an ESG fund manager favourite.

A genetic pioneer

Genus analyses animals’ DNA to identify traits that will be desirable to farmers, such as feed-efficiency, protein and fat content, and fertility. Once it has found these superior markers, Genus breeds them into its own elite proprietary herds of pigs and cattle. It then distributes said markers to customers in the form of breeding animals, sperm and embryos.

The group also owns tech that allows it to screen animal semen for characteristics such as female gender for the dairy market. It is also developing gene-editing technology to rear disease-resistant livestock.

Animal genetics is a niche industry; something which, on its own, adds depth to Genus’s business moat. But it helps that the group is the only listed porcine and bovine genetics company out there. Its rivals are mainly private entities and regionally focused farmer-owned cooperatives.

By comparison, Genus boasts international scale. And, sharpening its competitive edge, the group’s operations are fuelled everyday by a workforce numbering more than 3,100 – over 100 of whom have expert PhD level qualifications.

Genus’s two core businesses are ‘PIC’ (porcine genetics) and ‘ABS’ (bovine). PIC is the larger of the two, but revenues are well spread across both divisions. PIC brought in sales of £299m last financial year versus £238m for ABS.

PIC is the global leader in its field, with 16 per cent market share as of last summer. It owns more than 10 elite pure-bred pig lines, which are bred into much larger breeding herds in farms around the world. PIC also has boars housed in roughly 400 studs, where semen is collected before being distributed to customers and ‘multiplication’ herds.

ABS, which holds the number two position in the bovine genetics market, sells bull semen and embryos. In turn, farmers use artificial insemination to breed calves with attractive traits for milk and beef production. ABS’s semen is often sold in sexed form, heightening the chances of having female (milk-producing) offspring.

Genus's success is backed up by its investment in new products and infrastructure. Research and development (R&D) “is the lifeblood of our business”, it says, as it looks to "further strengthen our proprietary genetics and build capacity for future growth”.

In the 2020 financial year, net R&D investment rose almost a fifth to £65.2m, largely driven by higher expenditure on Genus’s porcine product development. Since 2016, R&D has escalated as a proportion of total revenues from 9.5 per cent to 12 per cent.

Admittedly, R&D investment edged down in the first half of the current 2021 financial year, but this was linked to short-term Covid-19 constraints and Genus says spending on the development of new technologies “remains a focus”.

On the bovine front, Genus continues to improve IntelliGen, its sexed semen technology, to help ABS meet global demand for its proprietary Sexcel product. The group has also produced gene-edited pigs that show resistance to the devastating pig virus PRRSv and has made submissions for regulatory clearance in China and the US. It has also started its ‘knowledge transfer’ to Beijing Capital Agribusiness (BCA), with which it established a long-term partnership in May 2019, to inform their development of PRRSv-resistant pigs in China.

Pig pandemics

PRRSv, an incurable respiratory and reproductive syndrome, is one of the most harmful pig diseases in China – a country where pork is the principal source of animal protein.

But it is not the only illness threatening China’s pigs. Far from it. During 2019, African Swine Fever (ASF) swept across the nation, which had previously played host to roughly 50 per cent of the world’s pig population. The epidemic more than halved its sow herd and caused a pork supply gap of 17m-23m tons in Asia.

It follows that Genus and BCA also plan to work together to develop solutions for ASF, among other major challenges in the Chinese pork industry.

For now, PIC has benefited strongly from the restocking of China’s pig herds in the aftermath of ASF’s destruction. The country’s pig farms, which are becoming larger and more professional, have taken the opportunity to enhance the genetic quality of their livestock. In turn, PIC revenues rose 18 per cent last financial year. More recently, they climbed 4 per cent to £153m for the six months ending December 2020, or 8 per cent at constant currencies.

The pig herd will ultimately be replenished in China, notwithstanding the fact that the ASF epidemic continues. But, arguably, the structural shifts in the market will have longer-term benefits for Genus now that it has established itself there.

Meanwhile, ABS's half-year sales climbed 9 per cent to £129m, underpinned by strong demand among dairy customers for Sexcel as well as Genus’s proprietary ‘NuEra’ beef genetics. In turn, Genus’s overall revenues edged up 6 per cent to £286m; not bad against the backdrop of a global (human) health crisis. Adjusted operating profits rose almost a third to £45.1m, aided by a 28 per cent improvement in ABS to £18.7m and growth of a tenth in PIC.

Helping to support continued R&D investment and service its debt obligations, Genus also more than doubled free cash flow to a record £26.6m.

Meaty multiples

Pigs can’t fly, but Genus’s shares have done so. Today, they command a sky-high forward price/earnings (PE) ratio of 46 times. Still, that multiple merits further rumination. “Genus is a unique, strategic asset, whose competitive advantage is continually increasing and is able to reinvest at higher rates of return,” argues brokerage Liberum. 

Second-half growth this year is expected to slow down compared with the first, tempered by adverse currency movements. Moreover, the practice of gene editing does inevitably raise ethical questions of its own. But as things stand, Genus is a leader in a consolidating market supported by rising demand for animal products and limited natural agricultural resources. Beyond its work in the wake of ASF, success on its PRRSv resistance programme would be “potentially transformational”, Genus says.

Last IC View: Hold, 4,964p, 3 Mar 2021