Description

Imerys offers a unique opportunity to invest in a high-quality specialty chemicals business trading at <6x normalized P/E despite stable growth and 10%+ ROIC for transitory and understandable reasons. Imerys owns massive deposits of valuable minerals which serve as the basis for pricing power versus more commoditized chemical companies.  In fact, Imerys has a #1 market share position in product categories comprising more than 75% of its revenue and its lead over its competitors is typically significant. When new CEO Conrad Keijzer joined the company over a year ago, the shares appeared fully valued at >16x forward P/E. Prior to Mr. Keijzer joining Imerys, the company’s management team appeared stable but uninspired.  Management spoke little English (Board meetings were in French) and seemed unable to drive organic growth, margin expansion or shareholder value. Just 12 months later, the new CEO has improved Imerys’ business quality through divestitures and closures of lower quality businesses. Imerys now trades at <9x current year/trough P/E and the targets of the new, highly reputable CEO translate to a valuation of <6x 2022 P/E.  Additionally, the dividend yield is very healthy at 6.1% and protected by a strong balance sheet (1.6x net debt/EBITDA) and robust free cash flow (9% yield). The opportunity to invest in Imerys at this price exists for four explainable and largely short-term reasons. After a >50% peak-to-trough fall in the share price, we are now presented with a fantastic entry point to invest in a high-quality business led by a proven new CEO.   

New CEO: Conrad Keijzer

New CEO Conrad Keijzer joined Imerys in March 2018 and quickly finalized the disposal of its roofing business and closed others underperforming businesses.  As a result of these actions, the new Imerys is less cyclical than it was prior to Mr. Keijzer’s arrival. Prior to joining Imerys, Mr. Keijzer ran the Performance Coatings (“PC”) business of Akzo Nobel.  As head of PC for Akzo, Mr. Keijzer’s drove margins from 9.6% to 13.0% from 2011-2016 (EBITDA margins from 11.8% to 15.9%). He did this despite significant cyclical headwinds in two of the business’s largest end markets, Marine and Oil & Gas, during 2016.  This resulted in PC becoming the best performing segment at Akzo Nobel under Mr. Keijzer’s tenor. Mr. Keijzer’s current incentive package is among the best we have seen for French CEOs as he can earn shares worth 300% of annual salary/year (€2.8mm in stock/year). This is incremental to the $1.5mm+ worth of stock he already owns.  In aggregate, this all represents a material portion of his net worth.

 Business Description/Quality

Imerys is the global leader in Minerals Processing (active in 142 countries).  With >75% of sales derived from market dominating positions (and 15% as #2 or #3 player), it is easy to understand why the company was one of the few chemicals companies that made money through the Great Recession.  In fact, margins troughed at 8.3% in 2009 vs. 11.4% in 2008 and rebounded back to 12.2% in 2010. The fact that >15,000 customers generate sales of €4.6bn for Imerys provides further comfort that the Company is in the driver’s seat for contract negotiations on their typically mission-critical, non-substitutable products.  The company’s end market exposure is extremely broad, which provides significant diversification across various industry end markets. Overall, this is a steady growth business supported by attractive themes including ageing populations (diatomite-based products, used for blood fractionation to separate proteins for immunotherapy) and electric vehicle growth (conductive additives mainly graphite-based for Li-ion batteries).  Imerys also has some exposure to slower growth markets like pulp and paper.

Dislocation

Shares of Imerys de-rated from the high 80s to the high 30s for the following four reasons:

1) Talc litigation: In April 2018 J&J and Imerys were fined ~€95 million due to asbestos contamination in talc powder (baby powder).  This triggered further lawsuits and settlements. Imerys had 3 subsidiaries that sold talc in North America (~3% of revenue and EBITDA). These subsidiaries are all fully legally ring-fenced and cannot impact the rest of the Company.  The subsidiaries are currently in Chapter 11 and the Company has sufficiently provisioned €250mm for all legal liabilities and costs. Due to its predominately French shareholder base, the share price plunged as these shareholders failed to understand and appreciate the US bankruptcy process.  We believe the legal liability associated with these subsidiaries is not a significant issue.

2) Portfolio Pruning: The new CEO divested and closed a number of lower-growth/marginally profitable assets and business lines including Imerys’ roofing business (sold), the US proppants business (closed), and the Namibian graphite operations (mothballed).  Given that most of the proceeds from the roofing division disposal (>€1bn) were used to pay down debt, EPS estimates fell by ~20%. That said, the businesses sold (roofing), bankrupted (talc) and closed (proppants) were either collapsing (proppants), lower quality (talc) or cyclically peaking (roofing).  The remaining businesses are much higher return assets that deserve a significantly higher multiple to reflect their attractive characteristics. Further, the Company now has capacity for bolt-on acquisitions, buybacks and aggressive high-return cost-cutting initiative.

3) One-time Charges and Cash Flow Upgrade: The impact of these major portfolio shifts and the beginning of the “heavy lifting” on the operational turnaround generated significant “clear-the-deck” one-time charges that impacted reported earnings.  Similar to Ton Buchner, Mr. Keijzer’s former boss at Akzo Nobel, Mr. Keijzer “kitchen-sinked” his first year guidance and declared an end to “recurring, non-recurring charges”, which he believed had caused value-destruction and capital misallocation over the last several years.  We expect cash flow to be roughly 70% of EBITDA and ~85% of net profit going forward (less than 100% due to high ROIC growth capex).  

 4) French Industrial Malaise: Imerys has not been helped by the industrial landscape in France.  French industrials have performed poorly over the past 18 months, predominantly due to auto and China related end market exposure.  It is easy to understand why Imerys shares were cut in half given sector performance compounded by litigation issues, complex closures and divestitures, and a one-time “kitchen-sink” to improve earnings quality.

Valuation

The shares currently trade at their 2011 European Crisis multiples despite a) improved business quality (no longer in building products or structurally challenged proppants), b) a MUCH better CEO, c) dramatically improved cash flow conversion and d) a significantly better economic backdrop.  We believe the share price should at least double over the next 2.5 years as the CEO proves out the opportunity. For context, Imerys’ closest peers, with exposure to drastically inferior end markets (more energy and pulp and paper exposure), trade at 8x EBITDA vs. Imerys at 5.5x trough EBITDA.

The Playbook

The CEO has communicated €100 million of savings at the Company’s first analyst day, which alone achieves the Company’s 19.3% 2022 EBITDA margin target.  That said, the CEO is focused on reducing fixed costs and improving operating leverage. This gives us increased conviction that the Company’s internal targets are much higher than its public targets. Our VAR suggests ample opportunities across this poorly integrated minerals conglomerate.  First, Mr. Keijzer is drastically delayering the organization, which mirrors what he did when he took over the Performance Coatings (“PC”) business at Akzo Nobel. When Mr. Keijzer joined Imerys there were 11 hierarchical layers between himself and the customer (10 at PC, which was a bigger business than Imerys).  He is rapidly whittling down the complexity at Imerys by reducing the number of organizational layers from 10 to 6-7 at Imerys (got to 5 at PC). In addition to saving tens of millions of euros per year, Keijzer believes that this will also enable greater empowerment, accountability and customer service. Second, similar to his experience at Akzo, there are large procurement opportunities via consolidating purchasing across the organization and introducing second and third suppliers in areas were Imerys has historically been a price-taker despite being the largest customer of the supplier. Third, the Company has an opportunity to integrate its numerous acquisitions and save money. Imerys made 23 acquisitions from 2011-2018.  From our diligence, these were barely integrated with >15 ERP systems across the organization today. Akzo Nobel PC was similarly decentralized and poorly integrated when Mr. Keijzer arrived after a long and expensive M&A spree. We believe Mr. Keijzer should be able to employ a similar playbook at Imerys with the help of many of his former team from Akzo.

There are also significant revenue opportunities from delayering and improving management quality.  Hundreds of customers were seen by multiple Imerys representatives from different divisions who did not communicate with one another. By simplifying the organizational structure, there should be significant cross-selling opportunities and improved customer service.  One of the things Mr. Keijzer was most surprised to discover after six months at Imerys (but also one of the most significant sources of upside), was how poorly Imerys was perceived by MOST of its customers. Due to Imerys’ dominant market positions, there is little customers can do but pay the price that Imerys demands and grumble.  However, there is little doubt that there are significant volume, mix and price opportunities with the improved organizational structure combined with more thoughtful and cohesive customer service. Additionally, allocating resources to higher growth geographies and end markets should improve organic growth and generate sensible bolt-on M&A prospects.  

Conclusion

The CEO has a strong operational track record from a comparable business and has strong incentives in place.  The business is high-quality, but poorly understood. The market dislocation is both discoverable and diligenceable.  The shares trade at a “double discount,” meaning they trade at a discount to a) peer multiples and b) historical valuation on trough earnings.  If the CEO is successful, returns will be generated from substantial earnings growth as well as a multiple re-rating.

Catalyst

Relief over 2019 earnings, quarterly execution, re-affirmed 2022 guidance, buybacks, M&A