Yule Catto's surprising strength

Yule Catto used to be dismissed as a perennial underperformer. That's understandable given its chequered history, spanning nearly 150 years and almost as many industries. But in its latest guise as a global supplier of polymers - a type of chemical - it's looking more focused yet better diversified than ever before. Judging by its resilience during the recession, its plan is paying off.

Yule Catto's slogan these days is 'being part of our lives'. That sounds twee, but makes the point that the company's chemicals are used in products as ubiquitous as carpets and condoms. It has global leadership in a couple of markets, notably the latex polymers used to make rubber gloves. It also has high market share in the UK and some emerging markets - Malaysia, South Africa, Saudi Arabia - for so-called dispersion polymers used to make paint and varnish.

These products, while low value-added, should ensure decent future growth. Sales volumes of dispersion polymers are volatile because they are used in the construction industry. But the company's geographic spread means it is more exposed to infrastructure projects in the developing world than to UK construction. Emerging economies make up 44 per cent of group sales, mainly in Asia, South Africa and the Middle East.

Morevoer, latex is a fast-growing niche that proved resilient in the recession. Even with a dip in 2009, Yule Catto's latex sales have grown at 6 per cent a year for the past eight years. That's partly because of demand from the medical industry and partly because Asian factories supply their workers with a constant stream of protective gloves.

Sales volumes should show a marked bounce when Yule Catto reports its first-half results on 27 August. Elementis, which sells products to the paint industry, reported a 41 per cent rise in revenues for the first six months. Yule Catto didn't fall as far during the recession so won't rebound to the same degree, but the precedent is encouraging.

Profits will depend not just on sales volumes but also on raw material prices, which are mainly driven by the oil price. That has often been a source of concern, but was a boon for Yule Catto last year. Now oil is again on an up trend, but so far this year the company has passed on higher input costs to its customers. Besides, Yule Catto's resilience to recession was partly because it has been improving its efficiency. Some labour costs will return with higher volumes, as Yule Catto took full advantage of European Union schemes allowing for temporary layoffs, but others will not.

That said, Yule Catto's profit margins, which were 9.5 per cent last year, will never be as high as other chemical groups whose products are more sophisticated. That suggests its shares will always be rated below its peers. But the current disparity - Yule Catto is rated just shy of 10 times City earnings forecasts for 2010 compared with 13 for the chemicals sector, according to Bloomberg - looks unwarranted.

It partly reflects Yule Catto's debt pile, which forced the board to axe dividend payments last year. But excellent cash generation has almost halved net debt. At £88m - 1.3 times cash profits - it looks manageable and the board has already promised investors a payout of at least 5p per share for the current year.

The low rating also reflects Yule Catto's history of restructuring, which has often dogged the income statement with hefty and confusing exceptional charges. Last year was no exception, as the group cut £30m off the goodwill associated with its peripheral pharmaceuticals division, which makes ingredients for generic drugs. But its painful transition to being a focused chemicals manufacturer is now largely complete - 84 per cent of sales come from polymers - so any further hits are likely to be much lower.