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John Engle
John Engle
Articles (125) 

Elementis, My Dear Watson

This British specialty chemicals business offers intriguing prospects

May 15, 2018 | About:

Sometimes it can be worth looking for value further afield. Elementis (LSE:ELM), a global specialty chemicals business based in the U.K., is a case in point. The stock is listed on the London Stock Exchange and is currently trading around £2.90 per share (about $3.94 a share), with a market capitalization of £1.35 billion ($1.84 billion).

Elementis is divided into four segments: Personal Care, Energy, Coatings and Chromium, with the company increasingly shifting its focus to the consumer goods industry and away from industrial applications. Personal Care now accounts for over a quarter of revenue and about half of net profit, whereas historically the Coatings segment delivered the biggest profits. A major aspect of this restructuring effort was the acquisition of SummitReheis, a manufacturer of the active ingredients in antiperspirants. Here we discuss the company’s prospects, particularly with regards to this strategic shift.

Financials

Elementis has produced some impressive financial results this past year. Total revenue for the end of 2017 was $830 million, up 23% year-on-year. Operating profit jumped to $128 million, an eminently respectable increase of 32% year-on-year. Debt is also up year-on-year, with the company moving from a net cash position of $77.5 million at the end of 2016 to a net debt position of $291 million at the end of 2017. As this was due to the SummitReheis acquisition, we do not expect this to present significant issues for Elementis, particularly since revenue and earnings growth has been so strong.

SummitReheis has already contributed $102 million in sales and $17 million in operating profit over the course of the nine months prior to the end-of-year report and management has already credited the merger with $5 million in cost synergies. This goes hand-in-hand with a wider effort to refocus capital expenditure, with management closing down a number of smaller, disadvantaged assets.

Positives

We see a number of growth drivers for Elementis going forward. First, additional investment in sales and technology has provided the company with access to a much wider range of markets. In particular, growth in Asia increased by a whopping 46% over the course of 2017, and management is confident they are well-positioned to build on this in 2018.

Second, management has credited the increased demand for a wider range of color cosmetics in the consumer sector as another driver of growth. The company’s competitive edge in the production of rheological additives (the components responsible for the consistency of creams and make-up, as well color stability) such as hectorite gel, puts Elementis in a good position to respond to this demand. In 2017, the amount of products in the personal care industry containing the company’s hectorite-based gel increased by 7%.

Third, the Chromium segment remains a stable money-maker. Elementis is the only producer of chromium chemicals (used in wood treatment and leather finishing, as well as the aerospace industry) in the U.S., and the exclusivity gives it a unique advantage within the American market.

Dangers

There are two main risks facing Elementis. The first concerns the cyclicality of the price of aluminum and zirconium, as well as acrylates and quaternary amines, which are key components of Elementis’ products. 2017 was a bullish year for raw materials such as these, and the increased prices somewhat impacted net profit. However, the company performed admirably, demonstrating that this will not be a major systemic risk. Furthermore, management is moving away from purchasing raw materials at spot prices, opting instead to cultivate strategic relationships with suppliers and using hedging techniques to reduce the uncertainty inherent to the commodity markets.

The second risk concerns debt. We have noted that the shift to a net debt position due to the acquisition of SummitReheis is not in and of itself a problem, as we expect the new unit to continue to drive the kind of robust revenue growth that we saw in 2017. However, if Elementis were to decide to pursue a more aggressive merger strategy, raising more capital for long-term gambles, that could spook investors, causing the stock to sell off. That said, since management’s modus operandi for the last few years has been the pruning of smaller, less profitable divisions in order to focus on bigger fish like SummitReheis, we do not view this as a likely scenario.

Verdict

Overall, we like how management has restructured and redirected Elementis to cater to the consumer segment. The company has a number of competitive advantages, such as industry expertise and a diverse range of products and has delivered impressive financial results over the course of the last year. At 17.5 times earnings, the company is not a bargain-basement discount stock, but we think it is nonetheless a safe bet that has long-term value potential.

Disclosure: I/We own no stocks discussed in this article.

This article was co-authored by Stepan Lavrouk, an investment analyst with Almington Capital.

About the author:

John Engle
John Engle is President of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a Bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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