Description

The chem distribution business model is not new to VIC.  Brenntag, Univar and Nexeo have been written up multiple times before.   I recommend revisiting those write-ups for a refresher on the industry / business model.  Chem distributors are generally solid businesses.  At a current share price of EUR 67.66, 6.7x trailing EV/EBITDA and 7.6x forward consensus EV/EBITDA, I think shares are undervalued and should perform well over the medium term.

Univar saga misunderstood

The Univar merger saga left a bitter taste in many investors' mouths and raised questions over BNR management's trustworthiness.  Some of this has been alluded to on VIC message boards for BNR and Univar.  BNR shares dropped significantly when Bloomberg broke the news of BNR’s approach in December, and then recovered some of that when BNR said they terminated the DD.  If I was in BNR CEO / management shoes and I received an inbound from Univar’s bankers or mgmt in Q3/Q4 last year letting me know Univar is up for sale, would I sign some NDAs to take a look under the hood?  Absolutely.  I’d do it even if I held a CMD where I made no mention to my investors that I’m planning transformative M&A.  This is just a normal course of business, in my view.  The PrimeStone activist letter offers a number of good arguments against the merger; the biggest ones are the UNVR/Nexeo historical dissynergies, and the regulatory risks.  The UNVR/Nexeo dissynergies are a big reason why some of the longtime historical investors in UNVR had a bad experience.  The UNVR investment thesis was predicated on a ‘rockstar’ CEO in David Jukes and a transformational Nexeo deal.  UNVR CEO Jukes pretty much never owned up to the downsides of the deal (i.e. the dissynergies). UNVR was a ‘hedge fund hotel’, and over time large UNVR investors gradually lost confidence that Jukes was being consistently straight with them, and got out.  We’ll never really 100% know whether Brenntag would have independently arrived at the same conclusion and aborted the DD had Brenntag not come under activist pressure (chiefly from PrimeStone).   But I am pretty confident that Brenntag management & board are a lot more cognisant and aligned with activist investors now than before.  

Capital allocation derisked

Knowing that shareholders are paying close attention, Brenntag announced a 7% buyback authorization a few weeks ago, and I think the risk of large ‘transformative’ deals is off the table for the foreseeable future.

A split is not priced by the market

Brenntag trades at 7x trailing and 6.7x consensus forward EV/EBITDA.   Historically, the ‘combined’ chem distributors have averaged a multiple closer to 10x EBITDA.  9-10x EBITDA is also generally where PE buyers have repeatedly found success in acquiring the chem distributors, often levering them up 4x.  Earlier this week, Univar agreed to get sold to Apollo and ADIA for 7.5x trailing EBITDA.  I think that’s a pretty good deal for Apollo and ADIA.

Of Brenntag’s EBITDA, c.35% is from Specialties and the remainder is from commodity chemicals.  Pure specialty distributors are valued at 15x trailing EBITDA in the market.  Applying that multiple to Brenntag’s Specialty division values the remaining (‘Essentials’ i.e. commodity) business of Brenntag at 2x EBITDA.  Revaluing that to something more reasonable like 5.5x EBITDA gives a straight 40% upside to the share price. 

That ‘sum of the parts’ aspect has always been there for Brenntag (and Univar, too) for the last few years but it was hard to see a catalyst for that value to be realized.  So that is fair pushback.  But things have changed since the arrival of Christian Kohlpaintner as CEO of Brenntag.  Over the course of several conversations with him since he joined Brenntag, each time he has been progressively more & more moving in the direction of splitting Brenntag into two.  Outside pressure to do that has increased significantly after the December activist letter.   Brenntag’s valuation and share price are telling you that the market’s base case is that no split occurs.   Based on my experiences of dealing with the company, Brenntag’s communication style is very ‘ex-post’; they tend not to pre-announce or warn on things until they have all the details ironed out.   I believe things are headed toward a split of the company into two (specialties & commodities).  The CEO has said publicly and in meetings that lots of work has been done and lots of work is still yet to be done in creating the infrastructure for specialties & commodities to operate as independent businesses.  This is why despite the EUR 220M of ‘Project Brenntag’ efficiencies being reaped since Kohlpaintner came in as CEO (mainly by eliminating excess DCs), actual net profitability hasn’t improved much - investments are being made in making specialties more independent.  Another hint towards this came during the latest financial release, where some more inter-divisional costs were moved from the commodity division towards specialties, and the mention by the CFO of significant opex spent on 3rd party consulting work.   I think Brenntag’s quality of communication on this front will improve, and the market will increasingly price the probability of a split.  

Limited downside

Even if there is ultimately no split and Brenntag trudges along with its combined structure, the starting valuation is such that it is difficult to lose absolute dollars owning Brenntag equity.  Even if they underperform their target of 6-8% organic EBITA CAGR, the chem distribution market globally remains fragmented (Brenntag and Univar if combined would still have <10% share) and Brenntag could drive returns through further M&A.  The improved attitudes towards shareholder returns and closer shareholder scrutiny of management direction also limits downside.   On a more shorter-term basis, >50% of the questions Brenntag gets whenever they talk to investors and sell-side analysts are various versions of "how much did you overearn in 2022" and "by how much will your EBITDA crater in 2023" so I am of the view that any EBITDA moderation in 2023 is well-discounted into the share price by now.

Catalyst

Progressively more specific communication on corporate split

Organic growth

Tuck-in M&A

Dividends & buybacks