Exposure to strong growth trends, high cash generation and frequent special dividends mean speciality chemical businesses seldom come cheap. But the general gloom that hung over equity markets in the latter half of last year triggered share price falls across the sector, amid rising concerns that consumer demand is bottoming out.
A slowdown in Chinese construction, as the country shifts from an investment-driven economy to one led by consumption, has been a problem for some. For Elementis (ELM), this backdrop has seen demand for products that reduce solvent content in paint falter. To make matters worse, supplying additives for drilling is also no longer so lucrative, as the US fracking boom loses momentum.
Synthomer (SYNT), on the other hand, has had more to shout about, even if its emulsion polymers feature widely in the struggling Chinese construction sector. Capital spending, targeted innovation and a crackdown on fixed costs helped the group post underlying profit growth halfway through 2015 for the first time in three years. And if Chinese property prices start to recover after the introduction of local government subsidies for home sales, its sharp discount to peers could soon start narrowing.
Johnson Matthey's (JMAT) valuation is also starting to look enticing. Falling platinum and palladium prices have weighed on its precious metal products unit, although we would argue that the backlash stemming from the VW emissions scandal has been overdone. When news spread that the German car manufacturer had installed software designed to cheat tests, investors fretted over the possibility that diesel's days were numbered.
As over half of Johnson Matthey's revenue comes from its emission control unit, where diesel converters in Europe happen to be the most profitable line of work, markets started to panic. But given that high-mileage drivers still require fuel economy, and given that diesel is considered necessary to achieve 2020 emission standards, we reckon the reaction was excessively harsh.
Victrex (VCT) is another name with exposure to the buoyant automotive market. The group's PEEK Polymer - a high-performance plastic that's lightweight and very resistant to extreme temperatures and dangerous chemicals - is used to build lighter cars and planes capable of providing better fuel economy. To highlight its diversity, the product also helps transform smartphones and gadgets into thinner, more heat-absorbent devices, as well as making medical implants lighter, more flexible and easier to view with imaging equipment.
But despite boasting big exposure to a range of structural trends, a couple of grey areas have been weighing on sentiment. Unfortunately, PEEK's ability to resist heat and corrosive chemicals means it's often used by cash-strapped oil explorers. Another sore point for investors was management's recent pledge to give priority to investment over the payment of special dividends.
| Price (p) | Market cap (£m) | PE (x) | DY (%) | 1-year change (%) | Last IC view: | |
|---|---|---|---|---|---|---|
| CRODA INTERNATIONAL | 2,888 | 3,926 | 21.8 | 2.3 | 5.7 | Hold, 2,892p, 22 Jul 2015 |
| ELEMENTIS | 204 | 943 | 5.6 | 2.7 | -29.2 | Hold, 250p, 29 Jul 2015 |
| JOHNSON MATTHEY | 2,445 | 4,732 | 13.1 | 3.0 | -30.1 | Hold, 2,590p, 19 Nov 2015 |
| SYNTHOMER | 298 | 1,013 | 14.2 | 2.7 | 25.0 | Hold, 350p, 12 Aug 2015 |
| VICTREX | 1,514 | 1,294 | 15.4 | 3.1 | -28.1 | Buy, 1,860p, 09 Dec 2015 |
Favourite
We think markets are being overly pessimistic about Victrex. True, relying on oil exploration companies when Brent crude prices are at rock bottom isn't very helpful. But at the end of the day, this is a quality, cash-rich company with exposure to a number of other big structural drivers, and one that soon stands to benefit from the completion of a major investment programme. An exemplary track record and encouraging long-term prospects mean the shares deserve to trade at a premium to peers - as they usually do - and not in line.
Outsider
As mentioned above, Elementis faces a number of major challenges. That makes the shares, which trade at a forward price/earnings ratio of 15, look steep, even after taking into account growing speculation about a special dividend in the year ahead and the hype surrounding the imminent arrival of new boss Paul Waterman.
