|Shares Out. (in M):||135||P/E||21||19|
|Market Cap (in $M):||3,753||P/FCF||18||16|
|Net Debt (in $M):||180||EBIT||265||280|
Croda International is a best-in-class specialty chemicals business that will compound for years to come. It is not cheap in the traditional sense of low earnings multiples, but I believe it to one of the few undervalued quality businesses in the sector that is a case of long-term sustainable growth at high ROTCE for a price that undervalues this quality.
Why is Croda International a Great Quality Business?
Croda was founded originally in 1925 as a lanolin producer and was supplying lanolin and some of its derivatives to the US cosmetics industry. Between 1960-1990, the company became a bit bloated via a series of acquisitions that build it into a diversified chemicals company. Since mid 2000's Croda had changed its strategy to focus only on niche specialty chemicals with attractive qualities of high pricing power and high criticality, which has transformed the business into what it is today over the last decade. A key part of this transformation was its 2006 acquisition of Uniqema from ICI.
2. Operating Segments
Croda has 4 main business segments
Business Division Revenues % Operating Margin
a) Personal Care 35% 25-30%
b) Life Sciences (Health & Crop Care) 20% 25-30%
c) Performance Technologies 34% 15-20%
d) Industrial Chemicals 11% <10%
By divisional sales and margin, personal care and life sciences (previously known together as consumer care) is clearly the most significant division for Croda. At this point in time management sees developing the performance technologies area as a second focus area as they believe there is margin potential to be realized. Over time it expects margins in that division to approach those in personal care and life sciences.
Personal Care i.e. cystine hair smoothing ingredients for hair straightening product, ingredients in tanning and sun protection (UVA/UVB) products
Health Care i.e. flavored emulsion products for dietary supplements
Crop Care i.e. formulation of adjuvants, herbicides, seed treatments
Performance Technology: Most of this business was acquired 5 years ago through the Uniqema acquisition. Croda supplies lubricants and other ingredients into finished products which add to the function or performance of the end product in a critical way. Products included are lubricants, coatings, polymer additives.
Industrial Chemicals: This category with lower margins is the more commoditized specialty chemicals that are essentially a leftover business from the historical Croda business. Products include leather additives, non-ionic surfactants.
3. Absolute Focus on Customized High Value Products
While a lot of companies say they focus on the highest margin areas that are the highest growth…
Croda has built a special expertise that is difficult to match.
a) In more than 80% of their Personal Care and Life Sciences offerings, the products they supply are customized products meaning they were co-developed with and specifically for customers. For example, (and this is the norm rather than the best example) Croda works with internal R&D departments at P&G or L’Oreal and focus on areas where Croda more know-how and expertise than the customer i.e. anti-aging ingredients. The business is highly tailor made and switching is almost impossible as the L’Oreal face will be marketed with active ingredient X.
Croda spends ca. between 12%-14% of its sales on R&D. But what is more important is that they track the productivity of this work in a detailed manner and report regularly the % of products sold that have been developed in the last 3 years. The amount of this is roughly 20%.
Because of its ability to focus on critical products that are a small fraction of the overall cost of the end product but are performance critical, Croda is able to price based on value. Croda is probably one of the best if not the best company I know at executing on this value based pricing in a systematic and completely committed way.
If they cannot apply value-pricing, they will discontinue the product line. Between 2006 and 2010, the volumes of the Uniqema’s original business declined dramatically while profitability increased dramatically. I know few other companies that have had the courage to discontinue business as consequently as Croda.
6. Sustainable Growth
Croda is in areas (Personal Care, Healthcare, and Performance Technologies) that are not only growth areas, but have had long track record of growing in the high single digits on average (~ 5-12%).
We aren’t extrapolating, but only seeing the evidence and understanding what is happening:
The sectors in which Croda plays are those in which customers generally expect that 50% of innovation comes from their own R&D (cosmetics is an example), and where 50% comes from their suppliers. As such, we see little risk that customers will insource more of this in the future: that doesn’t make sense and they simply wouldn’t be able to in all the niche areas.
As a result of this (with few exceptions i.e. last year), Croda is a business that has grown and we expect will continue to grow top line at high single digit rates for a long time. In addition to this they will continue to benefit from increasing margins as they are able to further continue their trend of improving % of revenues from new products over time especially in Performance Technologies.
7. ROTCE and Ability to Compound
As a result of the excellent margins/ability to price based on value/and relatively low capital intensity in niche specialty chemicals, the return on tangible capital for the Croda business has been > 25%.
Most important to the ability to compound is the combination of high ROTCE but only in combination with certainty in growth. We believe this is the case with Croda.
The management team led by CEO Steve Foots is excellent in our opinion and has a proven track record of increasing value for the company and achieving high TSR over the years.
I will let you from your own opinion on the team, but our opinion of this team is amongst the top 10% of management teams I have met.
Why am I excited about a company that trades at 20x PER multiple?
As a classic values investor, it is difficult to justify paying any earnings multiples that look this high. Why am I still excited and think Croda is undervalued?
Over the last year, Croda had several quarters of subpar growth due to difficulties with amongst others its cosmetics customers (L’Oreal etc.). These companies were having a difficult time in parts competing in emerging markets vs. some of the native champions. I did not and do not believe this is a long term issue: (a) the multi-national companies can and have been buying these local champions, and become smarter in addressing the different needs of those markets (b) Croda is one of the best exposed specialty chemicals companies to EM and secondary customers through its dedicated highly trained sales force, and even if only local champions would be successful in capturing all those EM markets, Croda will with time capture this market. The numbers in the last quarter is already evidence that this issue is being resolved.
In the long run, the real value is not the amount of growth (top line let’s say 8% yoy plus a bit more from margin increase), but from what I believe the is the relative certainty of this growth. I believe Croda’s is in control of its own destiny (not exposed to too many cyclical markets – relatively little oil/commodities etc. markets) and because of its high ROTCE and consistent growth at ~ 10% for what I believe is going to be a long time – is one of the few companies of this quality that is undervalued; which I think in today’s investing environment is not easy to find.
|Entry||07/13/2015 06:39 AM|
You imply that last year's top line decline was aberrational. However, when I look at historical financials it appears that the top line has barely budged since 2010. Annual revenue growth over that period has never exceeded 3%. How do you get comfortable that revenue growth will suddenly accelerate to high single digits? Is it simply that management says that the industries they serve grow at those rates?
The company does seem to have carved out a unique niche given the high ROICs, but I hesitate to pay 20x for a business that doesn't have some wind at its back on the top line.
Thanks for the idea.