Description

Company Background

Univar Solutions (UNVR) is a leading, U.S.-based full-line chemical distributor.  The company purchases chemicals from thousands of chemical producers, and then warehouses, repackages, blends, dilutes, sells and transports the chemicals to 100,000+ customers.  Chemical distributors’ value-add to chemical suppliers is providing inventory that allows for just-in-time delivery and easy product availability for their customers.  Additionally, Univar blends and packages product as necessary for chem customers, ensures safe and secure delivery that is regulatorily compliant, and acts as a sales agent for more specialty chemicals.  Value-add provided to chemical customers is that Univar provides a one-stop-shop for thousands of SKUs, and an information source for more obscure specialty products

The company was founded in 1924, but didn’t become the largest chemical distributor in North America until acquiring McKesson Chemical Corp in 1986.  Their US share was further solidified with its purchase of ChemCentral in 2007, Basic Chemical Solutions in 2010, and Nexeo Solutions in 2019.  Univar originally IPO’d in 2002, and then was acquired by CVC Capital for $2.0bn in 2007, and then CD&R for $4.2bn in 2010.  CD&R began its exit by IPO’ing the company in summer 2015.

Univar is the #1 player in North America, and #2 player globally.  Total global chemical demand (pre-pandemic) is ~$4.5 trillion, of which ~70% is distribution-relevant demand.  Out of these distributed chemicals, only ~11% are distributed by 3^rd party distributors like Univar, given chemical suppliers largely transport bulk shipments themselves directly to large customers.  For chem producers, ~80% of their sales are typically concentrated in the top 20% of their customer base, so they tend to transport product to their larger customers themselves that require large volumes.  Univar and other distributors specialize in warehousing and transporting chemicals that are not purchased in bulk, but rather by customers that spend only <$125,000 or less per annum.

Both the North American and global markets for chemical distribution are relatively fragmented.  Univar’s #1 share in NA equates to 13% market share (vs Brenntag at 10% and IMCD at 2%), and Univar’s #2 share globally equates to 3% market share (vs Brenntag at 5% and IMCD at 1%).

Thesis

For Univar, the decade prior to Covid had been challenging, and it showed through a lack of consistent EBITDA growth.  High management turnover and chronic underinvestment (while PE-owned) drove most of Univar’s historical issues, such as an inefficiently incentivized sales staff, antiquated IT systems, poor on-time deliveries and a lack of centralization.  These issues had all largely been fixed before the pandemic, though the company didn’t have enough time to show it through more consistent operating performance prior to the pandemic’s distortions.

For example, prior to 2017, Univar’s sales staff incentive was sales volume $s driven, which led to sales staff being incentivized to cut price to drive volume.  This upset chemical suppliers who felt their product was being cheapened by Univar which led to chemical producers withholding future business from Univar, especially for specialty chem products.  This also led to sales staff concentrating on selling high volume, low margin product, which was a misallocation of distribution resources. Stephen Newlin (prior CEO/Executive Chairman) enacted a new sales force compensation structure in 2017 to combat these misaligned incentives, which led to a 1x increase in churn that year (to ~40%) as salespeople used to the prior structure were managed out.  Sales staff incentive was now based on gross profit $s after logistics costs, and not $ sales volume, and sales staff could no longer control pricing.  There was a shift from generalist sales staff to those focused on certain lines of business.

Univar was also plagued by late delivers prior to Covid, something the company was on the cusp of fixing right before the pandemic.  From 2008 to 2014, Univar’s US on-time delivery rate stayed at a paltry 75%, versus industry norms closer to 95%+.  Given on-time delivery is the #1 priority amongst surveyed customers, Univar’s poor performance was a key structural headwind to sales, and was another factor leading to Univar’s consistent price discounting to move product.  On-time delivery rates were low b/c of (1) inefficient, long-distance shipping and (2) outdated IT systems. The long-distance shipping issue was caused by the sales force not taking operating costs into consideration because they were incentivized purely on volume.  Frankly, in many instances, the sales force didn’t have an accurate read on their cost of delivery anyways, given the company’s antiquated technology.  As a result, product was being shipped uneconomically from far-away locations in order to satisfy local customer demand to meet local managers’ sales goals, adding stress and complication to Univar’s network, ultimately leading to late deliveries.  Regarding the outdated IT systems, Univar’s CRM was outdated, which caused disappointing on-time delivery statistics.  Its CRM was from the early- to mid-1990s, was DOS based, and required knowledge of very specific codes in order to get product shipped.  Experts suggest only a handful of people within Univar actually knew how to use the system, leaving much of the company to “fly blind,” leading to late shipments.  This delivery issue was fixed also by the sales force changes: on-time delivery returned to a normalized 95% level, as the company re-incentivized sales staff on delivered gross profit (i.e., gross profit after outbound freight and handling), which limited expensive shipments from far-away warehouses to meet volume quotas.  In addition, the company invested in a new SAP ERP system as a part of the Nexeo acquisition, which led to improved on-time delivery.

Management turnover had been a problem from 2009 to 2018, with the company having been managed by 4 CEOs during this period.  Univar’s relatively high CEO turnover rate happened for a mix of unrelated reasons (e.g., wrong industry fit, or CEO found a better opportunity), but has contributed to the company’s inconsistent multi-year operating history.  The appointment of David Jukes stopped this cycle, as he was universally well regarded and had been a successful operator for Univar historically.

Lastly, macro headwinds in ‘15/’16 and ’19 compounded Univar’s inconsistent operating history.  Declining North American energy markets and industrial production in ‘15/’16 led to a decline in profitability during this period for Univar.  In ’13, oil & gas represented 19% of Univar’s sales, but given declines in US oil rigs starting in ’15, this exposure has now declined to only 6%.  US Industrial production declined by -1%/-2% in ‘15/’16.  Both Univar and Brenntag experienced -LSD% to -MSD% core EBITDA declines in developed markets in 2019 due to weak industrial production.

Altogether, for the ~ decade leading up to Covid, Univar had a challenging, undesirable operating history due to multiple factors.  However, these problems had largely all been addressed and the company was at an inflection point before Covid hit.

Post Covid (e.g., in 2021), as the country struggled with supply chain issues, Univar (like many distributors) benefited from a combination of inflation and the increased value associated with owning your own supply chain during a period of supply chain constraint.  EBITDA grew to above normalized levels (per the company’s own admission), and the market rightfully feared that there would be some reversal in earnings power post Covid.  Given the uncertainty between how much EBITDA was sustainable and how much was not, UNVR’s valuation recently has dropped to an ~8x P/E, levels never seen during its public trading history except during the depths of Covid.

My thesis on Univar is simple: it’s a market-leading distributor with competitive advantages (i.e., scale enabling more efficient distribution, first-mover-advantage which benefits the company in its sticky customer relationships with specialty suppliers which rarely churn suppliers, and a strong reputation in the industry and long-term tailwinds to chemical production and distribution from re-shoring activities in the US), and its valuation is disrupted b/c of (1) a historically challenging operating history for the decade prior to Covid that the company has not yet fully been able to prove that it’s in the past and (2) concerns that its earnings power is unsustainably high.  In terms of the challenging operating history, I’ve outlined above all the fixes that were just beginning to show pre-Covid.  In terms of earnings sustainability, if you take EBITDA from 2019 (i.e., $704mm), add on core pricing inflation (i.e., 1% core pricing, so not giving credit for the incredible chem price inflation in 2022), incremental gross margins on volume, add in the Nexeo synergies, its “value capture” cost savings program, and then factor in headwinds like opex inflation, you get to an EBITDA very similar to its $960mm of discussed sustainable EBITDA.  Univar trades at 6.6x EV/EBITDA on this sustainable number, a valuation not seen in its history except for the lows of Covid, by either itself or its closest peer Brenntag (BNR GY).

Catalyst

Core operating performance