Why Ascendis went down

The warning signs were all there in the financials, writes Nigel Dunn

Ascendis Health fell 77% in 2018, one of the worst-performing shares on the JSE. Were there signs of impending trouble? If so, what were they?

Ascendis Health is an Sabased international health and wellness company. Founded in 2008 and listed on the JSE in November 2013, the group has supplemented its organic growth by buying complementary businesses.

Since 2015 it has acquired four businesses in Europe: Farmalider in Spain (pharmaceuticals and over-the-counter medicine); Remedica in Cyprus (generic pharmaceuticals); Scitec in Hungary (sports nutrition); and Sun Wave Pharma in Romania (nutraceuticals).

The largest European acquisitions were Remedica and Scitec, costing about €500m.

This analysis of Ascendis relies on return on assets managed (Roam), the capital structure of the group and the returns generated thereon.

Roam is derived from two ratios: Earnings before interest and tax (Ebit) margin; and asset turnover (ATO).

Roam has almost halved, to 6% from 11% at its peak in 2015 (Figure 1). Ebit margin has been constant around 12%-13%, 2016 being the exception (Figure 2). ATO has almost halved from its 2015 peak. Given the limited compression in margin, the conclusion is that the increase in the balance sheet has not been matched by an increase in earnings (Figure 3).

Many investors fixate on earnings and earnings growth (income statement), ignoring the health of the balance sheet, in essence the engine of the business. Roam is a simple ratio that addresses that.

Return on equity (ROE) and return on invested capital (ROIC) paint a picture of a business struggling to earn an acceptable return, be it on shareholder funds or the total capital invested in the business: 4% and 2% respectively (Figure 4). This affirms what the deteriorating ATO shows: the group overpaid for acquisitions. The falls in the two ratios also flag a group whose capital structure has deteriorated at both the debt and issued share capital level.

The debt/equity ratio, sharp increase in shares issued and poor returns confirm a group with a deteriorating capital structure, with a concomitant increase in risk. The debt/equity ratio is close to 100%, while the number of shares in issue has increased by 150% since 2013. The group borrowed heavily to fund acquisitions, partially supplemented by two rights issues: R1.2bn in 2016 at 2,200c per share, which was heavily oversubscribed; and R750m in 2017 at 2,000c per share, which was not fully subscribed for, some investors having doubts then (Figure 5).

Ascendis highlights the dangers of fixating on Ebit, or the more commonly used earnings before interest, tax, depreciation and amortisation. Interest paid and depreciation/amortisation are costs incurred in operating a business. Depreciation and amortisation are not a cash charge, but need to be accounted for, so provision is made in the accounts to replace assets at the end of their useful lives.

Comparing Ebit with the earnings before tax margin shows a different picture: the interest charge of R395m reduces the return to 7% (12%) (Figure 6).

Figure 7 highlights the real problem — despite a significant increase in the asset base, revenue and earnings have failed to keep pace. The group has not extracted the synergies hoped for, be they improved efficiencies and/or costs saved, and overpaid for assets.

A review of the financials