|Shares Out. (in M):||52||P/E||11x||9x|
|Market Cap (in $M):||3,656||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||1,420||EBIT||0||0|
The company's typical customer is a small business with about $7MM of revenues. It buys roughly E2,000 worth of chemicals from Brenntag every week or about E100K per year. Brenntag supplies its customers with chemicals that are critical to their day-to-day operations but make-up only a small proportion of overall expenses. As result, Brenntag’s typical customer cannot afford to hire dedicated procurement personnel with expertise in chemical markets and consequently suffer from limited visibility into sport price trends and sourcing options. This unique combination of small dollar ticket, high operational importance and opaque pricing, allows Brenntag to charge a nice spread for its services and earn returns on capital in access of 20%. It also enables Brenntag to pass along swings in chemical prices and protect the amount of absolute gross profit dollars it earns through fluctuations in commodity prices.
The market in which Brenntag operates benefits from structural tailwinds that work in favor of large independent distributors at the expense of smaller competitors. The chemical industry is in the midst of a long-term phase of consolidation amongst producers. Consolidation is a result of the ever increasing pressure on manufactures to offset raw material inflation through economics of scale. As producers expand in size their appetite to directly serve small customers diminishes. Shipping minor amounts of volume of chemicals in less than full truck loads is less economically profitable versus serving large buyers who can absorb bulk transports in full trucks or better still through train car loads; also maintaining a large sales force to serve many small customers becomes unattractive relative to operating an account team that handles a limited number of large buyers (the ratio of revenue per sales person is favorably skewed to working with big customers in a commodity oriented business such as chemicals where price premium is hard to come by for manufactures). Consequently, producers have been steadily outsourcing their distribution towards independent players such as Brenntag, who can aggregate small quantities of product from different manufacturers into efficient scale. Over the last 15 years the market for 3rd party chemical distribution has grown in High Single Digits in real economic value-add terms (that is, excluding the effect of chemical price inflation). We believe there is still ample growth ahead, as the percentage of 3rd party distributors has reached only 30% of the small customer segment in 2010 versus about 15% in the mid-1990s, representing about 1% of market share gain every year.
As OEMs grow in size, they are consolidating their 3rd party distribution relationship to reduce supply chain complexity and costs. Producers are therefore gradually deprioritizing their cooperation with small distributors that operate on a local basis and buy small quantities. These small distributors cannot gain access to products at the same price and operational flexibility afforded by manufactures to large players such as Brenntag. Small 3rd party providers are therefore likely to lose share to big distributors that can offer end customers more flexibility in product delivery at quicker response times, two of the elements most critical to small end customers, even before price. As a top player in each of its geographical regions of operation, Brenntag is well positioned to gain share from local competitors.
We estimate that the combination of attractive market growth rates and improving competitive dynamics will allow Brenntag to grow gross profit at mid-single-digit rates over the next business cycle and beyond. With growth we expect the company to drive operating margin expansion from several sources within its internal control. Net, EBITDA should compound at 8-9% over the cycle. Combined with ~33% financial leverage, we see Brenntag compounding value at around 12-13% before redeploying its cash. The company’s business model is well suited to handle acquisitions of smaller players that lack scale and can expand their margins to reach Brenntag’s corporate average once consolidated. Brenntag’s past M&A performance supports our favorable view on capital deployment. We estimate that with tuck-in acquisitions and buybacks, Brenntag will be able to compound value at a yearly rate of around 20% over the business cycle. At the current price of Euro 71 per share, we own the business for ~9X our 2012 cash earnings estimate. We view this as an attractive entry multiple for a defensive business with good long-term compounding ahead of it, and in which time works in our favor as owners.
The key risks for permanent impairment of capital stem from the potential for intensifying competition between large independent chemical distributors, possible misuse of capital by management and a prolonged economic recession.
On the competitive front we currently find little signs of intensifying competition as the largest players focus on regions and product sets with limited overlap. Brenntag and other large players are spending most of their attention on share gains from smaller ‘mom-and-pop’ competitors and on wining more distribution volume from OEMs. We estimate that they do not have a rational reason to compete directly for at least the next two business cycles. That is, the large distributors have a rationale incentive to avoid direct competition with each other and instead focus on the meaningful sources of profitable growth from low penetration rates for 3rd party distributors and natural advantages for large players versus sub-scale ‘mom-and-pop’ operators. In regards to management’s use of capital, we have not found any reason for concern, and find comfort in the Brenntag’s M&A model which relies on small tuck in deals. On the macro front we view the key risk as Brenntag’s exposure to Europe, which contributes about 40% of the company’s earnings. During the last recession Brenntag has proven its resiliency to economic downturns with gross dollar profits declining only about 4% in 2009 in the midst of a uniquely challenging economic crisis. This resiliency stems from Brenntag’s pricing power over its end customers, which allows the company to maintain the required spread it need to earn good returns on its operational assets (in other words Brenntag was able to charge customers almost the same amount of dollars for distribution regardless of the lower volume of chemicals it delivered during the downturn). We believe Brenntag will be able to cope well with future economic downturns.
|Subject||Thoughts on the quarter?|
|Entry||11/11/2011 08:14 AM|
Any thoughts on the quarter? I think I read in a note that they are getting 12% in price? Very impressive...
|Subject||RE: Thoughts on the quarter?|
|Entry||11/11/2011 10:30 AM|
Q was inline and supportive for the long-term thesis.
Don’t focus too much on the revenue line and swings in the chemical prices that drive the expansion/contraction in the revenue line - it is a pass through that fluctuates with commodity markets - the real net revenue for BNR is the amount of gross profit it takes in - that is what they are left with after passing the commodity price and charging their fee for distribution. What is interesting, and we believe still misunderstood about BNR, is that they charge a flat amount in the short-term (and growing over time) for their distribution, regardless of the price of the commodity. Examine the invoice that they give to the customer once a week - it is typically about Euro 2000 per customer. About E1550 is for the chemicals, E300 is for packaging and transportation and E150 is the profit spread BNR takes in. The key here is that the customer has little pricing power around the spread that BNR takes (the cost of distribution plus the E150 profit for BNR) - the customer is a small business that can’t afford, nor is interested, in accessing the chemical spot market, managing the inventory, mixing and delivery etc. for a piece of his businesses that makes up less than 2% of his revenues but is operationally critical. Hence the pricing power in BNR’s business. As a result BNR’s profitability is not that depended on chemical prices, and is not tied that much to the E1550 piece in the invoice that moves around Q to Q (which is what creates the 12% prices increase this Q). The real economic profit is a function of Volume X Spread for distribution. Actually, what happens in recessions is that BNR tends to push prices up to offset volume declines, which is the source of the business’s great resiliency (BNR also benefits during recessions from more tactical outsourcing by the chemical OEMs).
Now back to the 3Q11 – the Americas, Asia and Latin America (~67% of the business) were great, growing nicely and got margin expansion. Management was also quite bullish on the outlook and believes the US economy (43% of EBIT) is doing quite well. Europe (43% of EBIT) was flattish due to low-single-digit declines in volume (est.). With pricing increases, BNR still grew in Europe 1.7% organically (see paragraph above…). Management decided not to cut expense in Europe since they expect acceleration in revenues after the seasonally weak 3Q (summer and vacation in Europe). We prefer to assume Europe will be in a recession next year and volumes will decline, but GP amount will be offset with price increases and the flow of M&A executed in 2H11. As a result we expect Europe to be flat to up modestly on an EBITDA basis. Net net, BNR should be able to grow EPS at mid-teens in 2012. Long-term, we see BNR growing earnings in the low-teens before use of cash, thanks to the LT trend of outsourcing and grabbing share from mom-and-pops. With use of cash BNR should compound at 20% or more. At 9x FCF for 2012, that is a great bargain and this Q supports this view.
Hope that helps.
|Subject||RE: RE: Thoughts on the quarter?|
|Entry||11/11/2011 11:39 AM|
That helps, thanks.
So if you think about GP as the more relevant top-line, what do you estimate to be the annual contribution from price (in percentage terms) over the course of a cycle?
Thanks again. Great idea.
|Subject||RE: RE: RE: Thoughts on the quarter?|
|Entry||11/11/2011 01:35 PM|
Hard to separate - data on past suggests that 3rd party chemical distributors benefited from about 150-300bps of CAGR above the volume growth in end demand over the last 15 years within the addressable segment (small and mid-size companies) - that was mostly by taking share from from OEM distribution and through pricing power as well but what is the split is hard to say. Notice that large players like BNR grew faster by taking share from mom-and-pop 3rd party distributors. Importantly, there is still a lot more share to be had as OEMs outsource more distrubtion and move away from small local players towards the likes of BNR.
|Entry||11/14/2011 12:33 PM|
thank you for the interesting idea. Do you have any thoughts around valuation / intrinsic value? I appreciate there are no real comps yet there appear to have been couple of recent transactions in the sector, you reckon those multiples are useful for Brenntag read across purposes?
As I understand their two closest peers are PE owned, Brenntag is too expensive for an LBO (even if we would assume credit markets were open for this type of transaction), I am pretty sure Brenntag was shopped to other PE shops prior to IPO (as recently also happened with KDG / KBW in Germany), just a bit worried in a sense that these guys don't appear to see value in Brenntag.... so long story short: keen to understand your valuation of this asset? cheers