FTSE 350 Review: Find your niche in chemicals

The trick for investors is finding companies that can grow but are also defensive enough to hold onto profits when times get tougher. These operators are usually midstream links in supply chains (be they automotive or cosmetic), meaning cost pressures can be passed on to clients and end consumers. Inelastic demand for these specialised products also helps in straitened times as well, given they are not fighting for market share. 

That doesn’t mean it’s an easy sector: innovation and intellectual property growth are key to a steady business. 

Johnson Matthey (JMAT) is a good example of the growth-at-gigantic-cost approach. The company sold off its battery metals business last year and is now once again working out a post-combustion engine future. Margins suffered in the first half of its financial year due to a reliance on carmakers, as the company was squeezed by higher costs and a lag in passing those onto customers. But Johnson Matthey is a critical part of the automotive supply chain that is still catching up from the pandemic and the semiconductor shortage. 

The much more highly rated Croda International (CRDA) – with a price/earnings (PE) ratio of 28 times, compared with Johnson Matthey’s 11 times – shows a good mix of growth and stability in its end markets. Analysts at UBS see Croda’s operating profits and sales creeping up beyond £2bn, while its two key divisions, consumer care and life sciences, look to have steady operating profit margins of around 25 per cent and 33 per cent, respectively. The company sold off its industrial unit last year to Cargill for £800mn. 

Elementis (ELM) is exposed to both the beauty and automotive industries across its coatings and personal care segments. The most recent profit numbers, for the first half of last year, showed strong improvement on 2021 in both margins and sales. Elementis has upped prices as well to pass on its own extra costs, but warned of “weaker demand in European and Asian markets” for coatings, and weakened demand in the personal care division, although it said it was still performing well. These are areas that are determined by consumer spending power – but, like Croda, Elementis’ sales are protected by the critical nature of its products to broader supply chains. 

Even with conditions uncertain, consensus forecasts compiled by FactSet see cash profits hitting pre-Covid levels for 2022 and only dipping slightly in 2023. Importantly, debt is set to come down at the same time. The net debt figure – $367mn (£297mn) excluding lease liabilities as of 31 December – has long been a drag on the company’s valuation, but receiving $107mn for its chromium business by the end of March will handily reduce that figure.