Oct 10, 2022
Linnea Bengtsson, Analyst
Bagsværd is a pleasant suburb of Copenhagen, Denmark. It is a suitably understated setting for a business whose principal products – enzymes – few people ever give much thought to. Yet the enzymes Novozymes manufactures touch millions of lives and reduce emissions from many different industrial, agricultural and domestic verticals.
Enzymes are proteins produced by all living organisms, including bacteria and fungi. They are biological catalysts, meaning they speed up chemical reactions. Enzymes in our bodies help us digest food, for example. Scientists have so far identified more than 5,000 types of biochemical reaction that enzymes are known to catalyse. Yet, if treated correctly, these hardworking biological agents are untouched by the reactions they enable. Consequently, they can be used again and again – which makes them a highly effective way to make stuff happen at the chemical level.
With a share of almost 50% of the global industrial-enzyme market, Novozymes supplies enzymes and microbes for a wide range of applications. But a common theme across many of these applications is that its biological solutions make processes more efficient, saving energy, water and other resources.
For instance, washing detergents that contain certain enzymes can clean clothes better and at lower temperatures, hence requiring less energy. Incorporating enzymes in bread production can improve texture (or ‘mouthfeel’, to use the industry term), and also increase shelf-life, reducing food waste. In industry, using enzymes in textiles manufacturing can strengthen fabrics, as well as reducing energy consumption. In farming, enzymes can improve animal health, and help livestock achieve slaughter weights faster and with less feed. Novozymes reported that its enzymes avoided 60 million tonnes of CO2-equivalent last year by enabling low-carbon fuels in the transport sector alone, a figure that does not include its other business segments where we believe carbon avoided is also material.
You might wonder what an investor can learn by going to see a company whose principal work is at the microbial level. Visually, the most striking feature of Novozymes’ Copenhagen plant, which we visited earlier this year, is the giant fermentation tanks, the height of a three-story building. Through the small observation windows cut into the side, you typically see a white-ish foam, rather like a bubbling, boiling beer froth.
Novozymes employs teams of technical experts to analyse enzymes and microbes collected from around the world. Their job is to figure out what these tiny entities could be used for and how they can be commercialised. The latter happens via a method called submerged fermentation, whereby specially selected microorganisms are grown in a soup of nutrients under the specific conditions needed for them to thrive and secrete the desired enzyme. Few companies can match Novozymes’ expertise at producing enzymes with the precise properties required for a target application at such scale and at viable cost.
As investors, we have long regarded this ability to produce enzymes efficiently and at scale as Novozymes’ key competitive advantage. What we gained a new appreciation of during our visit was the extent to which Novozymes applies scientific and production breakthroughs made in one area to expand or enhance the biological solutions it offers in other end-markets.
This has a multiplying effect on the potential returns from Novozymes’ research and development (typically 13-14% of net revenues). Having achieved an increase in productivity in a bacterial strain used to produce an enzyme product, these benefits can be ‘cookie cut’ across the portfolio, whereas competitors with a narrower range of applications can only gain a slice of these economies of scale.
Overall, our visit strengthened our conviction that Novozymes has durable competitive advantages, which is one of the key criteria for us to consider a company for the Global Environment portfolio. Another is that a business must be exposed to the structural growth linked to the transition to a low-carbon economy, and we continue to see a significant opportunity for Novozymes in this regard, too.
Given the huge efficiency gains required to get to net zero, we expect demand for Novozymes’ bio-solutions to increase over the long-term (shorter-term, enzyme demand fluctuates based on multiple factors, including economic cycles and the oil price). Not only do we think the business has the potential to increase penetration of all of its current end-markets, it continues to find new applications for its ever-expanding library of bio-solutions.
Finally, while we don’t yet include them in our model, new industries that rely on enzymes are emerging in response to the climate crisis and other sustainability challenges. Among the most promising are enzymatic recycling, which has the potential to revolutionise our ability to tackle plastic waste; enzymatic carbon capture, which doesn’t require the same volume of chemicals that conventional carbon capture systems do and is potentially more cost effective; and new methods of developing alternative proteins, a food group that will likely be essential to feed the world’s growing population sustainably.
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