- The group is looking to focus on its faster-growing personal care and life sciences divisions
- A review of its more cyclical businesses could see them demerged or sold
Specialty chemicals company Croda International (CRDA) has proved to be a high-quality and dependable holding for investors over the past decade. And amid the turbulence of the pandemic, it has outperformed many of its domestic and international peers, including Elementis (ELM) and Swiss flavour and fragrance giant Givaudan (CH:GIVN).
But with the shares having risen by almost 30 per cent since the start of last year, they are now trading at a rather lofty 30 times consensus 2022 earnings and the question is whether the future growth on offer can justify that high valuation? We’ve previously expressed concerns over whether Croda constitutes a ‘quality trap’, but the recent announcement of a strategic review of its ‘performance technologies and industrial chemicals’ (PTIC) businesses, could result in a leaner and higher-margin business that is focused on faster-growing end markets.
A shift in focus ‘makes perfect sense’
Croda operates across four divisions: personal care, life sciences, performance technologies and industrial chemicals. The latter two have more cyclical exposure, catering to the likes of the automotive and oil and gas sectors. While the group has been trying to refine its performance technologies business by shifting towards products for electric vehicles and wind turbines, the segment’s margin is still relatively low – the adjusted operating profit margin came in at 13 per cent last year, compared with 28.7 per cent and 32.2 per cent for personal care and life sciences, respectively.
The strategic review is expected to conclude by the end of the year and the process could result in a demerger or sale of all or part of the PTIC businesses. It is seen as a good move by Mike Fox, manager of the Royal London Sustainable Leaders Trust (GB00B7V23Z99), where Croda is a top 10 holding. “The performance technologies division serves more cyclical and less profitable end markets, so considering its future role in the group is sensible,” he says.
Croda is also a top 10 holding of the CFP SDL UK Buffettology Fund (GB00BKJ9C676), and manager Keith Ashworth-Lord concurs that it “makes perfect sense” for Croda to shift away from its PTIC businesses. He “hope[s] to see a spin-out, maybe by distribution in specie, to existing shareholders rather than a trade sale.”
The group has been trying to increase the proportion of revenue that comes from higher-margin ‘new and patent protected’ products – which accounted for 27 per cent of total sales last year – and offloading the PTIC divisions would allow it to focus on its main areas of product innovation.
“Higher level IP [intellectual property] resides in life sciences and personal care. These are premium products with a genuine economic moat, which is why they produce better returns and account for 80 per cent of Croda’s profits,” says Ashworth-Lord. “The performance technologies and industrial chemicals businesses, whilst not commoditised, are lower-margin businesses and largely standalone self-contained operations.”
Exciting growth opportunities ahead
Croda’s larger personal care segment has been squeezed during the pandemic as people staying at home lowered demand for ingredients for premium cosmetics. While sales dipped by just 2 per cent to £476m, adjusted operating profit dropped by close to a fifth to £137m.
Still, earnings should recover as economies reopen, bringing a return of social events and travel. Long-term growth drivers include rising disposable income in emerging markets, ageing populations and increased demand for sustainable products, and Croda is well-positioned given that its customer roster includes the likes of Unilever (ULVR) and L’Oréal (FR:OR). It should also start to see the benefit of last year’s €820m (£704m) acquisition of Spanish flavours and fragrance business Iberchem, which marked its first foray into the fragrance ingredients sector. The purchase will provide cross-selling opportunities and expand its access to high-growth emerging markets.
But the most exciting growth opportunity for Croda is perhaps in its life sciences business which, among other things, provides molecules that enable the active ingredient of drugs to be delivered more effectively to patients. Its lipid nanoparticles are crucial delivery systems for mRNA-based therapies, as they enable the strands of genetic material to reach and enter their target cells in the body without being degraded.
Only a few companies in the world are currently able to produce high-purity lipid nanoparticles at scale, and Croda joined these ranks when it purchased Avanti Polar Lipids last August for an initial consideration of $185m (£131m). This led to it securing a five-year deal to supply lipid components for the Pfizer (US:PFE) and BioNTech (US:BNTX) Covid-19 vaccine, and the group is guiding to at least $125m of revenue from this agreement in 2021, up from previous expectations of $100m. There could be more to come if orders of the vaccine are ramped up, and booster doses are required.
But the potential of lipid nanoparticles is more than just a short-term Covid story. Analysts at Berenberg believe the Avanti deal “bought access to technology that in our view will form the lynchpin of the successful rollout of mRNA technology not just in vaccines, but gene therapy more widely”. Indeed, there is an increasing focus on the use of mRNA technology to produce vaccines for other infectious diseases, such as influenza, as well as to develop treatments for cancer and autoimmune diseases. Berenberg estimates that the market for mRNA solutions could grow by more than 20 per cent annually for the next few years.
A clean bill of health
The M&A activity last year saw Croda’s net debt expand by almost 50 per cent to £801m, equivalent to 1.8 times cash profits (Ebitda). But broker Liberum estimates that following the Iberchem and Avanti acquisitions, 84 per cent of Croda’s adjusted operating profit now comes from defensive end markets, versus 68 per cent previously – and that’s before any potential PTIC disposal.
Croda’s near-term outlook remains positive. It says that momentum from the second half of last year has continued, with demand improving across all regions and sectors. If it decides to streamline its portfolio, this should improve its margins and growth rate, strengthening the long-term investment case of an already high-quality business. Buy at 6,542p.
Last IC View: Buy, 6,320p, 3 Mar 2021
