Description

I have written up Croda plc once before on VIC in 2015 when the company had revenues of just over GBP 1.0 billion and net income of 180 million GBP. The share price was at GBp 2750 per share at the time. Since then, the company has developed significantly over the last 8 years. It has grown its Personal Care business and its Life Sciences business by roughly doubling those in size (mostly organically), while also divesting most of its Performance Technologies business to Cargill in 2022. For more information on the basic nature of the business, please do refer to the original writeup. 

I wanted to write up Croda plc. again as an interesting long investment candidate as due to several factors, none of which I believe is structural, the share price has dropped from its peak in late 2021 of GBP 100 per share by almost 50% currently.

I believe this puts this high quality business again at a very reasonable valuation for its future prospects.

An update on the business:

As of end of 2022, Croda is now organized into 2 main divisions with the following financials:

Business Division                                    Revenues %       Operating Margin

1. Consumer Care                                 GBP 898m           22.8%
2. Life Sciences – Pharma                    GBP 682m           33.6%
3. (divested) Performance Tech.        GBP 509m           15.9%

As you can see, the main business units which were also present in 2015 are still existent but have grown significantly in size and also in breadth of specialty products provided. The Performance Tech. part of the business was divested in 2022 and will no longer be an ongoing part of the business. The average margins of the business will hence increase as well as returns on capital due to the mix effect.

Investment Thesis Going Forward:

In the last 6 months, Croda’s share price has dropped significantly due to a slowdown in overall sales and orders. Then on June 9^th this year, Croda issued a profit warning citing that projected EBIT for 2023 will be in the GBP 370-400m range compared to the expected around GBP 450m range (similar in 2022). The cited reasons were primarily twofold (1) weaker sales in consumer care and (2) a significant reduction in demand for crop protection products. I believe that neither of the reasons for the decreased earnings are structural in nature and at the current share price, the business is trading at an attractive entry point for a long investment.

1. Weakness in consumer care: The main issue here is a volume decline in the first few months of this year. This is on the back of very strong growth last year, which included a significant price raise. The main concern here seems to be if a portion of this is related to market share losses as a result of the price increase vs. it being mostly destocking, which the management believes is the larger part. While it is difficult to pin point how much of the reduction of the business was due to operational issues or overextending a price increase, these are items where Croda has a ability to address. For most of their ingredients the proprietary nature make price hikes annoying for their customers when too much, but do not cause those to turn to competitors. The destocking effect that is seen here especially in N. America and Europe is something seen also with their peers, and is not structural.
2. Crop protection demand: Here it is even more clear. End customers – farmers – are still buying and in need of innovative products. But in the direct customers of Croda who sell to farmers, there is too much stock and destocking will likely continue for several more quarters. This however, is not a structural issue.

More importantly, I believe Croda has several new areas of opportunity, where the next 10 years should be even better than the last decade.

First, while COVID related sales declines hide the inherent growth in the Life Sciences – Pharma business, there is very significant potential for superior long-term structural growth in this business. Croda is involved in a significant portion of future mRNA products, many of which are moving into Phase 3 in the next few years. These lipid development systems has a significant potential to grow for many years and is highly innovative and profitable.

Other than that, the resulting cash from the disposal of the Performance Technology business is already said by the management to be largely reinvested into growing the business and critical capacity. Much of this seems to be incremental to the maintenance CAPEX the business spends and hence should be seen as investments for more organic growth projects. As such, the result should either be incremental additional growth or a return of capital to investors, both of which are additive for TSR. 

As some of the volume issues from the above get reduced, Croda will again have better utilization, which we can with some certainty (as in the past) expect margins to further improve from here.

Valuation and Conclusion:

At a forward-looking EV/EBIT of 17x in 2024 and 16x in 2025, Croda seems to be trading at a reasonable valuation, and much lower than it has in the last few years. I see this as a good entry point to invest into a relatively stable long term compounder, with a proven history of focusing on maintaining a quality franchise. Croda has increased dividends for the last 25 years in a row, which just supports the stable nature of this specialty chemicals business.

Catalyst

Sharp share price drop that is not structural in nature.