Description

IMCD is an attractive specialty chemicals distributor that is positioned to be a long-term compounder for many years to come.

Headquartered in the Netherlands, the company is distinctly global in nature, with 35% of its revenue from the Americas, 44% from EMEA and 22% from Asia-Pacific. In the Americas, IMCD operates in the U.S., Canada, Brazil, Puerto Rico, Chile, Argentina, Uruguay, Colombia, Mexico, Peru, Costa Rica, Dominican Republic, Ecuador and Guatemala. In EMEA, it operates in Turkey, Israel, Egypt, United Arab Emirates, Saudi Arabia and Africa. In APAC, it operates in Australia,
New Zealand, India, Bangladesh, China, Malaysia, Indonesia, Philippines, Thailand, Singapore, Vietnam, Japan and South Korea. Its regional headquarters are in the Netherlands, Singapore and the U.S.

Management has been led by CEO Piet van der Slikke and CFO Hans Kooijmans, who have been with the company since 1995 and 1996, respectively. The company is effecting an orderly CEO transition to Valerie Diele-Braun, who has been on the IMCD board over the past few years and is presently CEO of Permira-owned CABB, a CDMO in crop science and life science specialty chemicals. IMCD was originally formed within the dutch industrials conglomerate Internatio-Muller in the mid 1990s as a new division comprised of specialty chemical companies focused on EMEA and Australia. In the early 2000s, management and a PE firm acquired the division out of Internatio-Muller. From then to 2015, the private company expanded, typically entering new regions via acquisitions, and raising capital through several rounds of PE investments. In 2014, the company IPO’d in Amsterdam. Since its IPO, the company has continued to expand, creating a global network of technical centers to support customers with high quality technical advice and formulation expertise.

Business Overview

IMCD distributes 50,000 products from 3,000 specialty chemicals and food ingredients suppliers to 60,000 customers. These chemicals go into sunscreens, hair conditioners, preservatives, pharmaceuticals, cleaning fluids, dishwashing detergent, car wash fluids, agriculture, printing inks, adhesives, sealants, construction chemicals, leather cleaners, beverages, chocolate, oil & gas processing fluids, water treatment facilities, etc.

IMCD represents suppliers often on an exclusive basis in a given region, and although winning a supplier mandate can be a lengthy process, the nature of the company’s collaboration with suppliers tends to lead to low supplier churn. IMCD provides suppliers with sales, marketing, distribution and formulation expertise, and often more efficient access to a localized markets (including assistance with regulatory compliance, adequate package labeling, etc). For customers, IMCD provides a single source for a broad range of products and value-added services. Customers can rely on IMCD to help them develop unique products to differentiate themselves from competition.

Suppliers often distribute directly to their larger customers while relying on IMCD and its peers to distribute to the long tail of small customers. The global chemicals distribution market remains significantly fragmented, leaving ample room for further consolidation.

Sales staff are typically incentivized with variable compensation in addition to their fixed salaries, usually linked to profit targets. Given the advanced formulations in much of the company’s products, sales associates and managers frequently have advanced technical backgrounds in order to best assist customers, such as prior degrees or work experience as pharmacists or in chemical engineering. 

Capital Intensity

IMCD has pursued a relatively capital light business model. Net capex in 2022 was €7.5m, or a negligible 0.2% of sales. The company operated 109 offices, 135 warehouses and 73 laboratories as of FY 2022, but relies mainly on leases to operate its business, which has led to healthy and growing cash flow from operations less capex over the years. Most of that free cash flow goes to fund acquisitions.

Acquisitons

IMCD is very acquisitive, and most of its operating free cash flow is typically redeployed into acquisitions. These acquisitions are typically very small and bolt-on in nature, and geographically diverse. YTD 2023, the company has closed or signed 14 acquisitions, comprised of 470 employees, which translates to an average of 33 employees per acquisition, evidence of the small size of a typical acquisition. To illustrate the broad geographic diversity of its acquisitions, in 2022 the company made 11 acquisitions: 4 in China and 1 in each of Australia/New Zealand; Japan; India; UK; Brazil; Colombia/Costa Rica/Peru; and Mexico. IMCD typically acquires its targets at valuation multiples materially lower than what its shares are trading at in the public markets, allowing acquisitions to be accretive.

Key rationales behind acquisitions include adding new or augmentng existing supplier relationships; expanding / deepening a geographic reach; revenue and cost synergies; attractive target price; and expanding a region’s product set. IMCD can bring a wide variety of resources to its much smaller acquisition targets to expand business faster. That includes the company’s sales force enhancements, such as the availability of product specialists, improved training and more advanced sales-oriented best practices. IMCD also deploys its ERP system, its business-to-business digital transaction platform, Salesforce CRM/Service Cloud and other tools at its newly acquired companies, to further drive efficiencies.

Acquisitions are not pursued via an auction type of process, but rather, IMCD has an internal understanding of the types of companies it’s interested in, and initiates conversations with potential targets that distribute for given suppliers IMCD would like to expand into, or have presences in certain geographies or product sets that would be additive to IMCD. Oftentimes, the sellers are not actively looking to sell their businesses, but via meetings over time (not infrequently over multiple years), the sellers determine that selling to and often joining IMCD makes the most sense for them.

Note also that as IMCD achieves further penetration, or “completion”, in a given value chain (ie. build out its product set, supplier relationships and customer network for cosmetics customers in western Turkey), it achieves margin uplift. So over the very long-term, IMCD should achieve margin expansion. But for our investable horizon, IMCD remains in an aggressive growth mode, and therefore will likely be willing to sacrifice margins to achieve topline growth, as I believe it should. Therefore, in the overearning discussion in this writeup, I target a normalized EBITDA margin of 8-9%, in line with the historical margins of the pre-pandemic era for IMCD.

Oftentimes, as IMCD pursues a new country, it identifies a target that can act as a platform, and then tries to coax existing suppliers to work with IMCD in the newly entered geography. Note that after some time, additional acquisitions are not as helpful in a given geography, because new targets may bring with them new suppliers that conflict with IMCD’s exclusivity arrangements – namely, that if IMCD is contracted to distribute a certain supplier’s product, it then can’t distribute a direct competitor product. So as a regional office matures, growth often comes from convincing customers to utilize the product that IMCD is supplying instead of the competitor product. Issues around mutual exclusivity is also a reason why acquisitions tend to be small – larger acquisitions would often result in exclusivity breaches.

Overearning

A key concern currently about IMCD and its peers is that the company has been recently overearning. Investors are concerned that its near-term operating prospects entail stagnant or declining revenue and reduced margins. In 2022, the company reported unprecedented revenue growth and profitability, some of which was fueled by stellar pricing trends, which management ascribed to supply constraints resulting from the pandemic. These trends have been reversing in 2023, with soft demand and pricing pressure triggering year-over-year declines in numerous metrics. 1H 2023 saw organic revenue down -6% and declining EBITDA of also -6%. In Q3, EBITDA declined -10% and earnings were -20%. Global chemical production has declined resulting from lower customer demand and ongoing inventory reduction, and that trend is expected to persist throughout the remainder of 2023. Ultimately, inventories will bottom out and growth will resume, but the timing of the cyclical troughs in IMCD’s end markets is unclear, and it’s also unclear where the company’s margins may bottom out at.

In the 2H conference call, the CFO said this about pricing: “I think that generally, our prices have been holding up quite well. So we are happy with that. There always in this broad portfolio, there are product ranges that are little bit more price sensitive and there, of course, we see some pressures. For example also because China opened up again and cost and additional competition, but I would say, by and large, because we are so specialty focus, our prices have held up quite remarkably well.” To me, implied in this comment is that there remains downside to pricing, and I don’t think it’s clear to anyone what is the magnitude of that. As a sign of this uncertainty, management declined to provide guidance in Q1 2023, citing “given the macro-economic uncertainties it is prudent not to give a near-term trading outlook.” In the most recent quarterly report for the period ending 9/30, management wrote “Due to current macro-economic circumstances, and considering the exceptional results realised in 2022, IMCD expects the outcome of this year to be below last year. However, IMCD foresees its performance to improve in the fourth quarter, relative to the prior two quarters.” When questioned about this guidance during its conference call, however, management wasn’t overly specific. In my mind, I’m not sure that Q4 will necessarily be the trough in its organic revenue growth and margin trends, and I’m not sure management knows either.

There are a variety of ways we could attempt to estimate normalized earnings, though the exercise will naturally yield imprecise results.

One way is to apply normalized margins based on historical precedents and adjust revenue downwards by applying a 2024 revenue decline to account for the pandemic surge in sales.

Prior to the pandemic, from 2014-2019, the EBITDA margin held steady between 8% to 9%. Today, the EBITDA margin has reached 12%, so we could assume that the EBITDA margin will ultimately retrace back to 9%. With respect to net income, its earnings margin was 4-4.5% pre-pandemic, and has since risen to 6-6.5%. This earnings margin is also at risk of normalizing to pre-pandemic levels over time.

Then with respect to revenue growth, revenue grew an average of 14% from 2014-2019. Following the pandemic, revenue soared 24% in 2021 and 34% in 2022, after a paltry 3% growth in 2020. Some of that boost from pricing will probably stick, and the company likely picked up extra volume from smaller players, so let’s assume a growth rate during that period of 16% annual growth – that would imply a -8% revenue decline from current levels to reach normalized revenue. So, re-adjusting revenue and applying a normalized margin yields approximately €400m of EBITDA, or 25% below current levels. That translates to a current EV/EBITDA multiple of 25x, versus a 16x-19x multiple in the 2016 to 2019 period. A valuation compression to 19x normalized EBITDA implies 25%-30% downside to shares, or a share price of €110-120. I’d be an aggressive buyer at that level given the overall quality of the IMCD story. At current levels, the argument that IMCD may be a little overvalued due to overearning has some merit.

Counteracting that is the fact that through organic and M&A-fueled growth, IMCD will be able to mask a slow multiyear post-pandemic normalization of growth and margin trends, capping downside to shares, and that pricing benefits from the pandemic will stick, at least for some time. The bull thesis is that IMCD will 'outgrow' the temporary overearning hurdles.

If anyone prefers an alternate way of calculating normalized P&L, please share in the comments, but my sense is that regardless of the methodology used, the results will tend to gravitate to 20%-30% declines in profitability in more draconian cases versus 5-15% declines in more optimistic cases. I think visibility into which trajectory will emerge may remain hard to come by.

Valuation

IMCD currently trades at 24x 2024E P/E, 17x 2024E EV/EBITDA and 2.1x 2024E EV/revenue. From 2017-2019, its average forward multiples were 22.4x P/E, 17.4x EV/EBITDA and 1.5x EV/revenue. During those years, note that IMCD shares doubled over that time, so its historical multiples in that era were too low. Taking a step back and understanding IMCD’s business quality, management competence, industry tailwinds, customer/supplier diversification and competitive advantages, a 25x-30x forward P/E is not an overly lofty valuation, assuming one is using normalized earnings. Using the broad figures from our overearning analysis, a 20x EV/EBITDA multiple off of normalized EBITDA yields a €120 price, where I think shares would be attractive to accumulate. I am comfortable owning some at the current price 20-30% higher, as long as I have capacity to add to the position at lower prices. My sense is that those lower prices would probably come as a result of overall softness in the chemicals sector (which can be triggered by concerns around the overall macro picture, given IMCD’s significant exposure to global industrials end markets), as well as earnings misses / disappointing forecasts by IMCD or its peers (Azelis, and to a lesser extent Brenntag and Univar). While misses and disappointments may trigger share declines, the reality is that any profitability declines will be cyclical in nature, whereas IMCD is overall a secular growth story with a long runway, and earnings misses and reduced guidance will ultimately give way to future beats. So lower share prices will probably present good buying opportunities if they’re triggered by 2024 misses due to the P&L normalizing from its elevated growth and margins in 2021-2022.

In terms of capital allocation, the company pays a small dividend, which amounts to around 1.5%. Stock-based comp is light, with the share count remaining relatively static over the past 3 years. The company has levered up at a reasonable pace as it’s grown, with net debt to EBITDA around 3x pre-pandemic, and is now sitting at approximately 2x. The lower leverage today is sensible to the extent 2024/2025 demonstrates that IMCD is currently overearning. Overall, IMCD and Azelis owe their roots to private equity ownership, and I find their approach to cost discipline, M&A growth and capital allocation to be responsible and intelligent.

As for the debate on whether to purchase IMCD vs Azelis, the stories are relatively similar. IMCD is a lot more liquid, so I find it more actionable, but Azelis is cheaper and could be considered more attractive from a valuation perspective if you’re fine with the lower liquidity. Azelis is also still private equity-controlled, whereas IMCD has a more diverse plain vanilla shareholder base.

Catalyst

- revenue growth and margins holding up in the coming quarters
- soft landing globally and a pickup in industrial end markets