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UK Quality: Darwall Buys Croda International

A quality stock from the London Stock Exchange

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The City Letter
Sep 15, 2021

Summary

  • Croda International is not a cheap stock, but it is predictable and has a high Altman Z-score.
  • Croda International was recently bought by the European Opportunities Trust, bringing it to my attention.
  • The business is benefiting from the vaccine boom and other secular trends.
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This article will be the first in my new series "UK Quality," in which I will take a close look at stocks listed on the London Stock Exchange that I consider to be high quality. An ititial quality screening typically relies on using fundamental variables such as return on equity, earnings variability and the debt-to-equity ratio. One shortcut we can use for this is the GuruFocus Predictability Rank. I also like to pay close attention to the Altman Z Score to ensure a stock is financially stable.

Croda International PLC (

LSE:CRDA, Financial), a UK-listed speciality chemicals company, recently came to my attention when it was bought by guru Alexander Darwall's European Opportunities Trust (LSE:JEO, Financial). Croda has a wide range of chemical businesses, including the manufacturing of lipids for mRNA vaccines.

Croda might typically be classified as a growth stock and might not be every investor's cup of tea. However, I classify it as a quality stock because of its sound balance sheet and fairly good predictability. According to GuruFocus, it has an Altman Z-Score of 6.68 and a Predictability Rank of 4 out of 5 stars.

Vaccine boom

As someone interested in the chemicals industry, I must admit I clearly underestimated the extent to which Croda would benefit from the ongoing Covid-19 vaccine boom. A significant rerating of the shares during the pandemic suggests that the market understood this better than I did, but Darwell’s purchase has bought it back to my attention.

In addition to its strong lipid offering for the mRNA technology, the legacy adjuvants and excipients products have also helped drive increased levels of profitability. Some analysts worry about the sustainability of Pfizer (

PFE, Financial) vaccine revenues, but with it being likely that we’ll all need booster shots as the vaccine begins to wear off over time and the virus evolves to new forms, this revenue stream has some legs. Also, Croda has a large number of other projects in this area and thus is not totally dependent on the Pfizer vaccine.

By my estimates, Croda’s 2022 Ebitda could rise to 726 million Pounds ($1 billion) for 2022 and at an enterprise-value-to-Ebitda ratio of 22.8 (not expensive given what Croda does), This backs out to a share price estimate of about £113, implying about 23% upside from today’s level.

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A closer look at Croda’s segments

Croda’s Life Sciences segment has overtaken Consumer Care as the company’s most important segment thanks to a very strong H1 performance. This was driven by both strong vaccine demand (volume) and improving margins (pricing). Croda are working on 100 Covid-19 related projects, of which roughly three quarters would add to revenue.

Management guided stable Pfizer sales for next year back in the summer, but I think this is conservative. Additionally, the strong pipeline should translate into strong growth.

That Croda generates a significant part of its Life Sciences revenues with Crop Care is also attractive. With industry-leading technologies and unique formulation expertise, Croda’s unmatched range of additives and adjuvants helps crop customers get the best performance out of their products, enabling farmers to get the best yields from their crops. In a world where crop yields are suffering from soil erosion, this is clearly a growth market regardless of the economic environment, given trends in population growth.

The Consumer Care segment is likely to grow strongly next year too. The biosurfactant plant is turning profitable, and the integration costs from the Iberchem acquisition are over. Coupled with the synergies achieved from that acquisition, earnings growth from the segment seems poised to continue into 2022.

Croda announced that 75% of the Performance Tech segment is being divested. This de-risks the business and helps Croda focus on its core competencies of Consumer Care and Life Sciences.

Valuation

A sum-of-the-parts valuation based on my estimates of revenue growth and Ebitda margins shows about 23% upside potential in the business. I don’t currently own Croda, but I respect Alexander Darwall as a stock picker a lot. After all, he has outperformed Buffett over the last 20 years.

Also, Croda seems to be to be a hedge against the Coronavirus being in our lives for a long time. Part of its business is tied to vaccines, which gives us portfolio upside if Covid-19 continues decades into the future, but the balance sheet is strong and so is the pipeline, which provides us downside protection too.

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Disclosures

I/we have no positions in any stocks mentioned, but may initiate a Long position in LSE:CRDA over the next 72 hours.
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