Swiss healthcare company Lonza (LONN:SWX) is a great quality business giving investors defensive exposure to a fast-growing sector.

With inflation subsiding and the Federal Reserve likely close to the end of its tightening cycle, Morgan Stanley’s equity strategist Graham Secker believes the US yield curve is likely to see a ‘bull steepening’ which historically has been bad news for stocks.

Bull steepening refers to the yields on shorter dated bonds falling relative to longer dated yields. With the MSCI Europe Quality index underperforming over the last three years, its weakest in over a decade, Secker argues now looks like a good time to add to quality stocks.

Lonza is a world leading contract development and manufacturing organisation which dates to 1897.

It operates as an outsourcing partner for biotech and pharma firms across the full spectrum of services from contract manufacturing and logistics to pre-clinical trials.

A key advantage of its business model for investors is that it gives exposure to fast growing biotech without being exposed to binary risks associated with individual clinical trials.

In addition to fast growth, Lonza’s sales and earnings tend to be more stable owing to the long-term contracts in commercial contract manufacturing which typically last 10 years.

The company has underperformed the market over the last 12 months bringing its valuation down to attractive levels. Though investors should expect to pay a premium price to the market average to reflect the quality and growth on offer.

A year ago, the shares were trading on 40 times expected earnings and have subsequently dropped to 35 times, representing a discount to peers.

Marcel Stotzel who manages the Fidelity European Trust (FEV) told Shares the team have been patiently waiting for Lonza’s valuation to drop enough to present a long-term buying opportunity which happened at the start of 2023, allowing the fund to add a new position.

SUSTAINABLE GROWTH AND SHAREHOLDER RETURNS

Management said the company remains on track to deliver medium term guidance of low teens sales growth and a core EBITDA (earnings before, interest, tax, depreciation and amortisation) margin in the 33%-35% range.

The business throws off a lot of cash. In 2022 it generated 18% of free cash flow as a proportion of sales.

The board believes it makes sense to pay excess capital back to shareholders via buybacks when the shares are attractive. Therefore, Lonza said it will start a CHF 2 billion share buyback in the first half of 2023 in addition to paying dividends.

Dividends have grown at a compound annual growth rate of 8% a year over the last decade.

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