Description

Dangerous Goods Logistics – A chance to monopolise a $40b industry

What do you get when you combine an intelligent entrepreneur with ambition and a propensity to speak his mind? Opportunity! Maybe not all the time, but in this bizarre instance you do.

Let me explain how an Australasian chemical company could potentially monopolise a $40 billion industry, and why we have the opportunity to buy into the business at a very reasonable price.

Note, all figures in this write-up are in Australian dollars, unless otherwise stated.

An overview

DGL Group Ltd, listed on the Australian stock exchange under the ticker code DGL, is a fast growing, vertically integrated specialty chemical manufacturer. Chemical warehousing and logistics, along with chemical waste and recycling, make up the balance of the business. The company has grown revenues from $100m in financial year 2020 to $370 million in 2022. An impressive 370% increase. Along with top line growth, EBITDA has grown from $12 million to $66 million across the same period, compound annual growth of 71%. Not only has the company grown EBITDA at this blazing pace, but they have also expanded EBITDA margins from 9% to 18% and still have plenty of room for improvement.

Founded in 1999 by Simon Henry, the company had its beginnings with the purchase of a 3.6 hectare specialised chemical logistics facility in Wellington, New Zealand. Simon had a vision of creating an integrated chemical handling business that would own the complete chemical life cycle for its customers. A Total Product Management system. He wanted to build a business that had the ability to manufacture chemicals, store and transport the chemicals, and recycle or dispose of the chemicals once they had reached the end of their useful lives. Simon spotted the opportunity amongst a fractured and fragmented chemicals industry. To this day, Simon and the company believe that there is no other competitor in the market that offers an integrated total product management solution. You either have chemical manufacturers, transport and logistics companies, or waste and recycling companies. An offering of all three combined, only exists with DGL.

There are many benefits to DGL’s integrated business model. Most importantly, the model encourages scale efficiency. The model pushes up asset utilization rates and profit margins. Operating 54 facilities across Australia and New Zealand, along with a host of additional plant and equipment, it’s important that these assets are utilized to their fullest. Higher utilization rates drive operating efficiencies and are a key reason for DGL’s expanding profit margins. For every additional unit of product manufactured on a particular site, the incremental profit margin of each unit increases. Economies of scale drive returns on invested capital. Bottlenecks in the supply chain are reduced. By controlling the complete cycle, DGL does not need to outsource aspects of the supply chain or manufacturing process. Case in point, they acquired their label maker in 2021 as they found the production of the labels didn’t always align with their distribution times, slowing down the delivery of the product to the customer.

For a customer, it makes sense that the company that is manufacturing their chemicals, should then be able to store the chemicals in a safe and secure facility and have the skilled staff to do so. It also makes sense that the same company transport the chemicals in a safe controlled manner to the site where the use case lies. Finally, if necessary, it makes sense that the same company disposes or recycles the expended chemical in a safe, controlled manner. The business model makes sense.

By offering an integrated service, DGL provides its customers with an outsourcing solution that saves them significant costs in an otherwise highly capital-intensive pursuit. If a manufacturer can formulate fertilizer, it does not always mean that it can also formulate pesticides. The plant and equipment required to produce different chemicals is often completely different from chemical to chemical. Certifications for the production and storage of chemicals also vary from chemical to chemical and the procedures and capital investment to obtain such certifications are onerous. Staff must be trained and certified. Combining the three divisions into one operation means DGL can send the customer one invoice, rather than the three they might receive if they had to go to three different vendors for each of the services offered by DGL.

DGL’s objective is simple. They want to be Australasia’s leading fully integrated, end-to-end chemicals business. They have clear strategic priorities to achieve their objective: 1) They will drive cross selling between segments. 2) Further economies of scale will be achieved. 3) Invest in capital projects. 4) Identify acquisitions.  

DGL’s three operating divisions

DGL’s operating model integrates three divisions: Chemical Manufacturing, Warehousing and Logistics, and Environmental solutions. The largest of the three is Chemical Manufacturing, generating 59% of the companies operating revenue in FY22. Chemical manufacturing has been the stalwart of the company since it’s 1999 inception and is the driver of the companies second and third divisions. Warehousing and Logistics accounted for 17% of revenues, while Environmental solutions accounted for the remaining 24%. Let’s take a closer look at each division.

#1) Chemical Manufacturing

DGL’s largest operating division, Chemical Manufacturing, produces its own range of specialised chemicals and also produces chemicals on behalf of its customers through contract manufacturing agreements. DGL develops its formulations in house with its team of specialised industrial chemists that operate in on-site laboratories. Once developed, the company owns the intellectual property for each formulation. DGL currently owns in excess of 60 registered trademarks for its formulations. In addition, DGL sometimes retains the IP for formulations produced on behalf of its customers, allowing it to bootstrap and innovate to develop new products for different applications without as much capital investment. DGL has capacity to manufacture 290,000 tonnes of chemicals annually.  

DGL is able to procure commodities used in the formulation of chemicals that most of its competitors cannot, given the strength of their balance sheet. An unscaled competitor does not have the financial means to invest in large amounts of base ingredients that will sit on its factory floor for an indeterminate amount of time. Doing so, strengthens DGL’s competitive advantage and the ‘stickiness’ of revenue. Customers rely on DGL’s balance sheet, ensuring repeat business for DGL. Of note, this strength was a major contributor to the strong FY22 results. Simon stated that their balance sheet strength contributed “opportunistic” earnings, on the back of the global political state of affairs and lingering covid supply chain constraints. He re-iterated that these earnings will unlikely recur with such scale in FY23 and further years to come.

Raising $100 million via the IPO allowed DGL to acquire Chem Pack, an Australian chemical manufacturer founded in 1993 (note that the total $100m raised in the IPO went to the company. Simon, the only shareholder prior to the IPO, did not sell any of his stock in the process). The acquisition significantly increased the size of DGL’s Chemicals Manufacturing division. The division posted revenues of $94 million in FY20 while Chem Pack generated $78 million over the same period. Hence, the acquisition nearly doubled DGL’s chemical manufacturing revenues. The $38 million acquisition was completed in January 2021, allowing for financial contribution in the second half of DGL’s 2021 financial year. DGL has shown they are highly capable of carrying out successful acquisitions, seamlessly merging target operations into the group. Chem Pack was acquired for about 5x trailing earnings before interest, tax, depreciation, and amortization (EBITDA). Consider: DGL generated $14m in EBITDA in FY20, Chem Pack generated $7 million. On combination, that’s a 50% increase to DGL’s bottom line.

DGL is currently trading at 7x trailing EBITDA, which means, upon merging, the value of Chem Packs business doubled from 5x earnings to 7x (actually 9x based on DGL’s multiple at the time), or from $38 million to $61 million. The power of scale, an integrated business model, and a public listing is powerful. I’ll be diving deeper into DGL’s valuation later where I’ll explain why I believe DGL is deserving of an earnings multiple greater than 7x in the long-term.  

DGL’s opportunity to monopolise a $40 Billion industry

The chemical manufacturing market in Australia and New Zealand is expected to grow from $39 billion in 2022 to $41 billion by 2026. A huge market, which DGL is poised to conquer.

The agriculture sector accounted for 36% of the company’s revenues in FY22. Fortunately for DGL, Australia and New Zealand are among the world’s top 20 agricultural producers. The industry is a significant component of each countries’ export revenues: Agriculture accounts for 55% of Australian land use and 12% of exports. New Zealand, with a population of only 5 million, accounts for 3% of the worlds dairy production. Producing this much food requires the application of specialised pesticides, herbicides, and fertilisers to enhance yield and maintain a competitive position in the market.

In Australia, drought conditions over the 2017-2020 period saw poor growing conditions. Rainfall has now returned, and growing conditions have improved remarkably with winter crop production in 2020 growing by 76% year-on-year, while summer production was projected to grow by 322% to 3.7 million tonnes.

Along with Agriculture, DGL can enjoy growth in demand from a number of other industries. The trend towards home and garden DIY along with detached dwelling demand from the Airbnb trend has seen demand for home and garden chemicals grow. Demand for chemically treated potable water has increased due to growth in the number of households: Coagulants and flocculants which DGL produces, are an effective solution to removing solids from water and enhancing the treatment process. Growth in the construction and infrastructure industry means demand for concrete has increased: Admixtures enhance the properties of traditional concrete, increasing the speed at which the concrete sets and enhances the ease in which the heavy concrete can be pumped into position. The Australian mining industry, which generates 75% of the country’s exports, employs 1.2 million people and generates $50 billion in earnings each year, relies heavily on chemical processes: Flotation chemicals are one method employed in the mining industry to increase the extraction rate of minerals and profitability per unit.  New applications for these chemicals are continuously being explored by suppliers and miners to realise cost savings, improve working environments, or to comply with regulations.

I hope I have outlined the scale of the chemicals manufacturing opportunity in Australasia. It is massive, and it is growing. DGL’s scale and financial strength means it can capitalize on the opportunity organically and via acquisitions. Among the seven acquisitions made in the first half of FY22, yes seven, DGL purchased a multi-purpose chemical facility in Townsville, Queensland, along with Opal, a chemical manufacturer that services the majority of agricultural chemical suppliers in Western Australia. The facility in Townsville will allow for a foothold into the Queensland market. Opal will contribute $2 million in EBITDA to the group, which will undoubtedly grow, while at the same time removing a competitor from the market. As per DGL’s strategic objective, they will continue to make acquisitions that make sense.

DGL will be consolidating the industry into their fold. If they can continue to execute, the prize here is significant.

#2) Warehousing and Logistics of dangerous goods and chemicals

Although a small part of DGL’s overall business, generating 17% of FY22 revenues, the ability to house and transport clients’ chemicals, along with its own, is a major strength for DGL and a core component of its integrated business model.

Again, DGL is benefiting from strong market fundamentals that will help drive growth for the division. Australia and New Zealand both benefit from strong economic pillars, a mature regulatory environment, and well-established infrastructure. Infrastructure is a priority for governments in both countries. Announced as part of the 2022-23 budget, Australia’s rolling 10 year infrastructure investment pipeline will increase from $110 billion to $120 billion, a new record. Inheriting a $33 billion four-year infrastructure plan, the Labour government in New Zealand has increased this investment to $62 billion over the next four years to 2026.

In FY22, DGL increased its owned truck fleet from 56 to 185. Of the 129-truck increase, 71 came via the acquisition of Shackell Transport in October 2021. Aligning with DGL’s strategy, Shackell has been servicing its customers across Australia with regional and interstate distribution and linehaul services in the food, mining, chemical, agricultural, building and construction industries. Showing a commitment to responsible capital allocation, DGL paid $9 million for the business, equating to 1x book value.

#3) Environmental Solutions

Hazardous waste comprises approximately 10% of the total $15 billion waste management industry. With ESG now a crucial part of business strategy, effective waste management and recycling has become ever more important. The Government of Australia has a goal of reducing waste by 80% by 2030, and since 2007 has reduced commercial and industrial waste by 15%. The market for waste treatment and disposal in Australasia is projected to grown from $3.3 billion in 2016 to $3.6 billion in 2026. Within this, liquid waste will account for approximately 20%, or $680 million by 2026.

A core component of DGL’s waste processing and recycling operation is the recycling of lead acid at the end of the useful life of a lead acid battery. These are the big batteries that run the electrical system in your car. It turns out, 97% of a lead acid battery can be recycled. The lead is isolated and turned back into bullion and ingots which can then be sold to the open market. Cue the opportunity for DGL. Using the funds raised from the IPO, DGL re-commissioned a previously mothballed lead smelter in Laverton North, Victoria, Australia. Within a few months the smelter was up and running. With an annual capacity of 50,000 tonnes of saleable lead, and at a lead price of $2,000 USD per tonne ($2,800 AUD), this lead could end up adding $140 million to DGL’s top line, which Simon Henry re-iterated in the IPO prospectus. Total tonnage of lead acid batteries reaching their end of life in Australia is expected to reach 181,000 by 2030, up from the current 160,000. DGL won’t be running out of batteries to recycle anytime soon.

To increase their waste disposal and recycling capacity, DGL is currently busy developing or commissioning a number of facilities. Commissioned in 1H22, their Ester processing plant in Victoria is experiencing high utilization with strong forward commitments. Another liquid waste treatment plant is being planned, currently in the consent stage. Commissioning is planned for Q4 of FY23.  

A fair price to pay

After all is said and done, what we are really concerned about here is what we can earn as shareholders of DGL, and therefore, what is a fair price to pay for the companies’ shares. Companies with such profitability and potential growth profiles like DGL are rare, and hence generally command premium valuations.

DGL’s advantage

As I’ve mentioned throughout this article, DGL has performed well both financially and operationally. The reasons for this performance are what I believe set DGL apart from the global cohort of chemical companies.

Devotion to the Total Product Management system

As I noted in the overview, DGL has maintained its objective of becoming a one-stop-shop for its customers since Simon Henry purchased the companies first site in 1999. In Australasia, no other chemical company like it exists. DGL is busy taking advantage of the market dynamic and could end up being the dominant player in the $40b chemical manufacturing space.

Management execution

Strong management execution is absolutely essential in driving business performance. Such execution shows up in a multitude of areas for DGL. Above, the stubbornness to stick to an objective for 23 years is impressive. The profit and revenue growth has been stellar. Execution of mergers and acquisitions have been on point, with reasonable purchase valuation multiples achieved. Essential, given that 55% of growth has come via acquisitions. The company has no intention of changing this balance.

Founder led

Simon Henry was the sole shareholder of the company upon listing. On IPO his shareholding was reduced to 57% and he maintains a steadfast intention of remaining a significant shareholder. As he said on IPO: “I will continue to hold a significant shareholding in the Company, as the largest shareholder, and I am committed to the success and growth of the company. I have not sold shares as part of the IPO process, and all capital raised will be reinvested in the growth of the business.” As acquisitions have partially been paid with stock, the total number of shares outstanding have increased since IPO, slightly reducing Simon’s shareholding to 53%.

Simon has bought shares on the open market three times in the past year. In June 2021 he bought 100,000 shares at a cost of $122k AUD, bought a further 178,000 shares in December at a cost of $500k AUD, and a further 500,000 shares in March of last year for total consideration of $1.4m Australian. Again, Simon bought shares in September 2022, and again in March 2023.

Simon has been described by his brother as someone with an entrepreneurial and individualistic take on life. As long as Simon can refrain from criticizing others in public, he’ll continue to be the right CEO for DGL. Sadly though, I am starting to think that his removal as CEO would be a positive catalyst for the valuation. As we all know its institutional funds that largely determine values and they are very woke in NZ.

So, what is DGL worth?

At a share price of $1.30 with 285m diluted shares outstanding, DGL is sitting on a market capitalization of $371m. With net debt of $80m, the company has an enterprise value of $450m. On a last twelve-month basis, DGL is trading at 9x EBITDA.

DGL’s shares have taken a beating from the fallout of Simons Nadia Lim comments (a TV personality in NZ – see here: here  (paywalled). He basically made a moderately sexist comment about her referring to how poorly her HelloFresh type company has performed post IPO in comparison to his) Adding to the downward pressure on the shares was the announcement alongside FY22 results that slower growth is expected for FY23. In my opinion, the companies’ shares have been oversold over the past ~8 months. Fundamentally, there is no denying the rapid growth DGL has been experiencing, nor the margin expansion, or the stellar management execution. This is a good business with a strong competitive moat, high barriers to entry, and a clear runway for growth.

For these reasons, I would posit 15x trailing twelve-month EBITDA is a conservative, fair price to pay for DGL. For further validation, much slower growing waste management companies were recently purchased for 20x. See here (paywalled). Now I’m not suggesting this will happen in this bear market, although I do believe long-term once this cycle reverses, 15x is reasonable. 

FY23 EBITDA was guided to between $71.5 and $73.5m at the half year announcement in Feb 2023.

Keep in mind, that the 15x multiple I posit is based only on past performance. There are a number of reasons why this multiple may increase over time: further economies of scale as the company grows, an inflection in free cash flow (which is likely not far away) that will allow DGL to self-fund acquisitions and capital expenditures, and doing away with leases and purchasing its plant outright: $9.5 million was spent on repaying lease liabilities during FY22, which, if reduced or removed, would increase EBITDA by 15%.

A quick peak at global Chemical peers shows an industry average trailing multiple of ~12x, vs DGL’s 7x. This is also based on a lower average 5-year EBITDA growth rate of 15%, vs DGL’s 90%.

A final note on risk

Apart from obvious risks that are found in the chemical manufacturing industry, there are some other key risks that I wanted to highlight.

One of the largest risks to the investment thesis would be if the company diverted from its strategic objective of becoming a total product management system. It’s possible that growth may eventually slow in chemical manufacturing or in the other two divisions leading management to look to diversify into other areas, turning DGL into a conglomerate. Doing so would likely reduce margins as out of place acquisitions are made. I struggle to see why Simon would have the need to diversify at this stage, so this remains more of a long-term risk.

Becoming a conglomerate leads me to a more near-term risk, poor acquisition execution. With 11 acquisitions made in FY22 and a further 4 to be integrated post balance date, the risk that any one of these acquisitions does not integrate into the wider group is real.

Lastly, if Simon decided to sell down his shareholding in the company, it would place a huge burden on the share price. Investor confidence would disintegrate. Simon also owns approximately 54% of the outstanding shares of the company. The average volume of stock that is traded daily is only 364,000 shares, so any open market share sales would place major pressure on the share price. With such a large holding, it is more likely that if Simon were to pursue a sale, he would do so via a block trade to an institution. I’m sure Simon has clear ideas on what he believes fair value for DGL may be, and I bet he thinks it’s greater than the current $500m the market is implying. With Simons comments around commitment to the long-term growth of the company, I again see this as more of a long-term risk.

Disclaimer: I am long the shares of DGL.

Catalyst

CEO exit.

Market correction.

Buyout. 

Free cash flow inflection.

Debt reduction.