Description

Tessenderlo is a specialty chemicals and industrial company headquartered in Belgium with the bulk of its operations spread equally between North America and Europe.  The company’s businesses span agricultural chemicals and sciences, animal by-product processing and a variety of industrial solutions including the manufacturing and distribution of plastic pipe systems and water treatment chemicals.  Close to 40% of sales and the vast majority of profits earned today is generated by the Agro business which manufactures and distributes specialty liquid fertilizers primarily in the US under the Kerley brand. 

Tessenderlo presents an interesting opportunity to partner with an owner-operator who is in the midst of transforming a decent set of businesses that have been sleepy, de-focused and, until 2013, controlled by the French State.  With the shares at €30, we believe we are paying a reasonable price for Agro and getting all remaining businesses and a strong operator/capital allocator basically for free.  We derive further conviction from our alignment with the principal shareholder who took his initial position in the company in 2013 and continues to date to increase his stake.  He has been buying regularly even in the last few weeks. 

Luc Tack, a self-made Belgian entrepreneur most recently credited with transforming an industrial company called Picanol, has been building a stake in Tessenderlo.  (For more background, see Frugal’s write-up of Picanol Group in September 2014.)  He bought out the French government's stake of 28% at the end of 2013 and has continued to buy shares in the open market to date.  His ownership in Tessenderlo of  more than €500mm (~33% of shares outstanding) represents the bulk of his net worth.  Luc is very low key taking pains to avoid media attention.  His record suggests one of high integrity and scruples.  For many years, he did not even draw a salary while running Picanol from 2009 and is currently paid a nominal base salary at Tessenderlo. 

The stock is not well loved.  In addition to its sleepy history which left investors apathetic, after assuming the role of CEO Tack eliminated the dividend that was satisfying the then controlling shareholder (the French State).  Subsequently in 2014, he also announced a rights issue to fund expansion.  Notably, he took up all his rights and then some allowing him to increase his stake beyond 30% without having to make a mandatory offer for the entire company.  These actions were disgruntling to shareholders.  Further, Tack is not that communicative.  In fact, the IR department was shut down soon after he became CEO.

Very few people follow the name and the businesses are not well appreciated.  This is likely to do with the fact that the company has historically operated in diverse areas.  Moreover, it has been undergoing a portfolio transformation since 2011, even before Luc Tack entered the picture, and has since shed 12 businesses and over 30% of its sales in more commoditized areas.  Over the same period operational performance has been volatile and, understandably, disclosures have been complicated by re-classification of divisions. 

We believe that under new leadership the company has acted with a sense of urgency, but is not taking a slash and burn quick fix approach.  They are taking a multi-pronged and long-term approach of generating cost savings, reinvesting in initiatives to drive toppling growth, and focusing on cash conversion.  They have already taken out €25-30 million in HQ costs through actions such as eliminating positions like Chief Growth Officer, reducing director pay, and eliminating annual meeting banquets, and have meanwhile reinvested some these savings at the divisional level in plant, technology and commercial initiatives.

We believe the Agro business has many years of strong top line ahead of it at continued solid margins of 20% or more.  The other businesses operate across diverse areas and today in aggregate generate close to €1bn in sales but not much by way of profit.  They should recover some of their lost profits and generate margins of between 5-10% or higher.  Some of these “other” businesses may also get disposed given their strategic value. 

We believe earnings can reach over €4/share over some years and the stock is an attractive purchase at 7.5x earnings power.  Our earnings power estimate is based on over €800m in Agro sales at a 20-21% EBIT margin, and €1 billion in sales from the other businesses at a 7.5% EBIT margin (mid of 5-10%).  At 15x earnings, the stock would be worth €60 leading to a double or a 25% IRR if this took place over a few years.

Alternatively, we estimate Agro will generate EBITDA of approximately €135 million this year, so at an enterprise value of €1.3 billion we are paying EV/EBITDA of about 9.9x for Agro EBITDA alone.  While that is not screaming cheap (specialty chems are trading at roughly 8.5-9.0x), we think it is a good business with good prospects, and we are getting the rest of the businesses and operational/capital allocation upside for close to free.

If Agro is worth 9x current EBITDA of €135m and the other businesses are worth 0.7x current sales of €940m, it would translate to a current share price of €42 or 40% near-term upside.

Agro Division (Tessenderlo Kerley, NovaSource)

The largest portion of Tessenderlo’s Agro division is a specialty fertilizers business (Tessenderlo Kerley).  Kerley is a leader in specialty fertilizers in the US.  Its historical financial performance has been good with decent growth, ROIC of 25-35% and margins in the high teens-low 20s even when under the control of the French State. 

These are niche products with the market being only a few million tons compared the products serving a distinct set of needs.  There is high cost of failure because inauthentic product or poor blends can result in “leaf burn” or crop destruction.  The company is the lowest cost to serve with an important advantage in sourcing sulfur at low cost given its refinery services business.  About 70% of its sulfur requirement has historically been sourced at zero cost, where in fact the company is being paid by refiners for treating their effluence.  In its largest products such as Thio-Sul, KTS and CATS, it holds market shares of between 60-100%. 

In addition to Kerley, the company has two other businesses in the Agro division.  One is a niche crop protection business called Novasource focused on high value cash crops.  The business model of NovaSource is unique in that it is a completely asset light (production is outsourced) marketing and distribution organization of low volume, niche herbicides and pesticides many of which are off-patent.  The Company has been acquiring such products at attractive multiples from large ag companies given the poor focus received by them in those organizations.  The markets are too small and these products would not have met the volume criteria originally anticipated during research. 

The company also has a sulfate of potash business in Europe which is a fertilizer used in growing high value crops like flowers, fruits and vegetables growing in arid regions or those that cannot handle chlorine.  In these high value crops, SoP is used to enhance product quality such as avoiding flat taste or increasing the content of storage compounds leading to “richness” in texture.  The market for Sulfate of Potash is roughly a tenth of the total potash market.  It is manufactured by very few players – K+S, Compass Minerals and Tessenderlo. 

We believe that the Agro division’s prospects are bright.  We’ve heard that there is renewed focus in growing the business.  Not just in theory as it was in the past, but with Luc Tack having bought a home in Phoenix, AZ (HQ of Kerley) and taking over also as the CEO of Kerley, a culture of “getting things done now” is developing.  Until recently, there has not been a sales force actively marketing the products/solutions in new geographies or to new customers.  That has started taking place in the last year with hiring/training of more sales folk to further penetrate existing markets like California and Florida and to grow in the corn belt/Midwest (serving broad acreage crops).  The company is also expanding the Kerley brand in Europe and Latin America.  This had been something on prior management’s agenda but was never executed with focus.  The company is also actively pursuing applications for their products in other markets like gold mining where their calcium thio-sulphate product is used as a leaching agent. 

The company is expanding capacity in a few major product lines and while numbers haven’t been disclosed, we think capacity increases of approx. 30-40% are coming online in 2016/17 supported by attractively situated raw material sources. 

On the cost side, the opening of facilities closer to customers (California, Illinois, France) is expected to lower transportation costs which were high given that the product is liquid and cost around $60/ton to ship on a barge (10-15% of selling price).  Also, in Belgium, the closure of the feed phosphates business led to underabsorbed costs which will be rolling off.

To date we have only seen a little bit of the changes taking place at Kerley in the numbers.  Improvement in 2014 performance was a function of reversing some of the hits the division took in 2013 due to inclement weather in the US and transportation bottlenecks.  Moreover, in 2014 and YTD 2015, we believe the SoP business has made some positive contributions coming from a very low base. 

Overall, we expect the Agro division to grow from €600mm in revenues today to over €800mm over the next few years and generate 20%+ EBIT margins.

Other Businesses (Bio-Valarization, Industrial Solutions)

There are several businesses here, each with different dynamics.  Many of them are good businesses and have decent barriers to entry such as regulation/permitting, route density, and brand.  But the reality is, today, as a group they make little to no money.  There are several reasons for that and each case varies.  One way to look at it is these businesses have had the perfect storm over the last few years and de-focused weak leadership and yet have managed to not lose money.  We believe the issues have more to do with the history and some cyclical challenges.  These were businesses that were wedged within a larger conglomerate whose focus in recent years was on pruning its sprawling portfolio and answering to a government shareholder.  There’s nothing particularly wrong with these businesses but there’s also nothing spectacular to write home about yet. 

We believe there is some value in these businesses and based on their history and some competitor performance, think they are at least worth 0.7x sales based on their ability to generate 5-10% EBIT margins and considering past transactions such as Darling Ingredients’ acquisition of Vion Food Group.

Bio-Valorization

Bio-Valorization consists of Akiolis and PB Gelatins which are animal by-product processing businesses.  For good background information on the industry, see Enright’s write-up of Darling Ingredients in October 2014. 

Akiolis is a rendering business in France that collects and processes of animal by-products from slaughterhouses, extracting protein and fat that is sold to different end markets including for pet food, animal feed, aquaculture, soaps and bio-fuel.  Economics are local as 50% of the raw material is water and gets evaporated, animals have to be processed quickly, and disease outbreak must be controlled, and local relationships with abettoirs matter.  It receives a collection fee from slaughterhouses as well as income from the sale of fats and proteins to food, pet food and oleochemical manufacturers.  Akiolis has the number 2 market share in France at 26%, with the top 3 players having a 77% market share.  Akiolis has suffered in the last two years driven by a price war that was initiated by the number 3 player – Verdannet-Monard – in an attempt to gain volume share.

The Gelatins business is a global business operating in a consolidated market dominated by the 3 players.  Tessenderlo is the number 3 player with a 14% market share.  This business processes skin, bones, hide and feathers to produce gelatin and collagen that is supplied into food/confectionary manufacturers, pharmaceutical, and nutrition end markets.  These products are added in small amounts to the formulation as a functional ingredient providing a specific property.  The gelatin business suffered in the last couple of years due to raw material inflation and, in parallel, food scandals in China involving a competitor. 

In the past, these businesses had generated 10% operating margins and 15% EBITDA margins at a mid to high teens ROIC. 

Industrial Solutions

This is a diverse set of businesses including a plastic pipes systems (PPS) business focused on public works, a water treatment chemicals business with a leading position in France and Belgium, a mining chemicals business that takes advantage of existing technologies in the group, a people intensive technical and laboratory services business (MPR), and services for the treament and disposal of fracking water (ECS).  These business have suffered from some cyclical challenges such as depressed end markets in pipes.

While we believe each of these businesses can be positioned as operating with good market shares (even leading in a few) in attractive niches and are capable of generating good margins, we think these businesses will generate good results because of good management focus and action rather than because of some positioning. 

Risks

Macro or end market cyclicality.  Management has commented that it “operates in volatile economical and financial circumstances.”

The Agro business is expanding capacity, so there is risk of underutilization if capacity is not taken up right away.

The “other” businesses may not create much value.  While historical performance would suggest that they would not detract value too, they may end up being a distraction to management.

Catalyst

Earnings, capital allocation