Description

Summary

Univar presents an opportunity to invest in a diversified, industry-leading chemical distributor at a compelling valuation. Univar holds the #1 market share of third-party chemical distribution in North America by a significant margin, an advantage that has increased with the acquisition of Nexeo. The chemical distribution industry is likely to grow at or modestly above GDP over time as penetration of third-party outsourcing increases, and industry leaders like Univar should be able to take share through scale efficiencies. Given the company’s modest leverage and counter-cyclical cash flows, it is well-equipped to manage through the COVID-19 downturn and will likely emerge on the other side with an even stronger competitive position. We believe that while chemical volumes will be negatively impacted by COVID-related disruptions, the demand for Univar’s products and services will be revived as the world returns to a new normal in the years ahead. 

The Business

Univar is one of the largest third-party chemical distributors in the world. The company purchases chemicals from thousands of chemical producers worldwide and warehouses, repackages, blends, transports and sells those chemicals to more than 100,000 customer locations across approximately 130 countries. Chemicals are used for a broad swathe of applications across the economy, and Univar is very diversified across end markets and geographies:

Chemical distributors add significant value to both customers and suppliers in the overall chemical ecosystem. Customers who purchase products through distributors simplify their supply chain and benefit from a lower total cost of ownership. They also rely on distributors for technical knowledge of the products, safe delivery and off-loading, and compliance with increasing local and federal regulations. Suppliers (chemical producers) rely on distributors to serve small customers efficiently, enhance their geographic reach, augment their salesforce, and lower their costs. Distributors hold products in inventory, break up bulk to make smaller deliveries, and help them meet the needs of a fragmented customer base.

Price is not the most important factor that either customers or suppliers use to decide which distributors to work with. Instead, they focus on a number of other factors including customer access, geographic reach, reputation, technical expertise, ability to offer value-added services, and safety/reliability:

Univar has several advantages relative to the hundreds of smaller, local distributors. First, both suppliers and customers have a desire to reduce the complexity of their supply chains, and Univar’s broad product assortment and geographic reach enable them to present a “one-stop-shop” approach. Second, Univar’s overall network of customers, suppliers, and transportation/logistics assets is very dense, allowing for economies of scale. Scale also enables Univar to exercise some leverage in purchasing and pricing discussions. Univar has long-standing and generally positive relationships with its customers and suppliers, though its personalized service levels may be somewhat lower than those of smaller, more focused distributors.

Univar has some level of supplier/customer concentration – the 10 largest producers accounted for 37% of total chemical purchases and the top 10 customers accounted for approximately 10% of sales. However, in general there is a long tail of customers and suppliers that Univar exercises considerable influence over.

Company History

The predecessor company to Univar, Van Waters & Rogers, has a history dating back to 1924. George Van Waters and Nat Rogers were both in their mid-twenties when they met over a game of bridge and decided to enter into business together. They each contributed $2,500 to start the business, which initially sold paint, cotton linters, raw materials, and naval supplies at wholesale from a small sales office they had rented. Over the ensuing decades, Van Waters & Rogers expanded through acquisitions to cover a wider array of products and geographies, and changed its name to Univar in 1974 following a merger with United Pacific Corporation. In 1986, Univar doubled its revenues by acquiring McKesson Corp.'s chemical distribution operations, making it North America's largest chemical distributor. The company expanded into Europe in 2001 with the acquisition of Ellis & Everard.

In 2007, Univar was acquired by CVC Capital Partners for $2.1bn (9x EBITDA). In 2010 CD&R acquired a 42.5% equity interest, leaving CVC with an equal stake and the remainder owned by management. The deal in 2010 valued Univar at around $4.2 billion (9x EBITDA). Under private equity ownership, the business continued to expand with acquisitions in Belgium, Turkey, Brazil, and Mexico. In 2015, Univar closed its IPO (priced at $22/share, 10x EBITDA) and concurrently completed a private placement with Temasek.

In March 2019, Univar, which was already the largest chemical distributor in the US, completed its acquisition of Nexeo, the #3 player in the industry. Nexeo was acquired for ~9x EBITDA (adjusting for the divestiture of the plastics distribution business), or ~5x EBITDA including net synergies. The significant expected cost savings from the deal stem primarily from overlapping warehouses and other overhead.

Nexeo was formed when TPG acquired the chemical distribution business of Ashland for $930mm (10x EBITDA) in 2010. The business was the #3 chemical distributor in the US, and the #1 plastics distributor. After the carve-out, private equity invested substantially in Nexeo, including new warehousing, trucks, and technology (SAP). In 2016, the business entered public markets by merging with Wilbur Ross’s SPAC. (Wilbur Ross resigned from the board of Nexeo in 2017 given his other obligations).

As a public company, Nexeo was very vocal about the potential to increase their profitability by filling up excess capacity in their logistical network. They estimated in 2018 that their North America operational network excess capacity was approximately 40-50%, and that profitability would improve as they flowed more volumes through the system. Consolidation of warehouse facilities is thus a major factor behind the cost synergies of the Univar-Nexeo merger. Significant progress has been made toward integrating the legacy Univar and Nexeo organizations, and management has good line of sight towards unlocking the $120mm of cost savings outlined in the merger.

Industry

Chemical distribution is a growing and highly fragmented industry. Barriers to entry are significant given that it requires a large and efficient asset base within a given region to generate economies of scale. Chemical distributors need large amounts of specialized equipment and warehouses. Also, given the hazardous nature of the materials transported, regulatory factors add more complexity discouraging new entrants. Finally, in many cases chemical distribution requires a salesforce with significant technical expertise, something that takes time to build up.

The chemical distribution industry is very fragmented, with the top 3 players (Brenntag, Univar and IMCD) representing ~10% of the global industry. This landscape has led to significant M&A and private equity interest in the space in recent years (Brenntag was previously owned by Bain Capital and BC Partners, and IMCD was previously owned by Bain). Chemical distributor M&A tends to be very accretive, as acquired warehouses can be consolidated with the acquiror’s existing network. 

The fragmentation of chemical distribution has important implications. For example, customers with a wide array of choices among distributors may have stronger negotiating positions. Some local mom-and-pop distributors, who still constitute the majority of the market, focus less on optimizing pricing than the large, publicly owned distributors. However, as the business becomes more and more complex, it is likely that less sophisticated operators will continue to struggle. With digital tools being used in warehouses and AI being applied to provide analytics and compete in the online marketplace, mom-and-pop businesses are increasingly competitively challenged. 

Traditionally, chemical producers distribute their own products. Direct supply still accounts for 85-90% of total global distribution. Large end-users in many cases buy directly from the manufacturer and dedicated “key account” management structures and processes have been set up by producers to serve them. However, for smaller customers and regions where producers have limited operations, most chemical producers struggle to develop an effective sales model, particularly as the need for greater cost efficiency has decreased the size of sales forces. 

The chemical industry is likely to grow at the rate of GDP/industrial production. It is likely, however, that third-party chemical distribution will grow somewhat faster than this, as today only ~10-15% of total chemical volumes move through third party distributors. This penetration is likely to increase at a slow rate over time due to the efficiencies of outsourcing distribution tasks. Third party distribution is much more highly penetrated in other industries.

Univar is certainly differentiated from the vast number of local mom-and-pop distributors due to its scale, breadth of products and geographic coverage, logistics/digital capabilities, reputation, and technical expertise. Brenntag is the only company that rivals Univar in the breadth and capabilities necessary to be a “one-stop-shop” for customers and suppliers. 

IMCD, another international chemical distributor, focuses only on the specialty chemical portions of the industry. This causes their approach to the business to be very different – for example, IMCD owns very few logistics assets. IMCD has grown rapidly since its inception in 1995. The company targets organic gross profit growth of 6-7% and grows well into the double digits through acquisitions. With ~$3bn in 2019 sales, IMCD is about 1/3 of the size of Univar, but larger in specialty chemicals.

Azelis is another important global player in the consolidation of chemical distribution. Azelis was sold by 3i Group to Apax Partners in 2015 and was then sold to EQT in 2018. Under Apax, Azelis acquired U.S.-based KODA Distribution Group, which was a roll-up of a number of distributors engineered by its private equity owner Audax Group. And EQT plans to support Azelis’ continued growth by leveraging its “experience with buy-and-build strategies”. Azelis had been planning for an eventual IPO but chose to sell to another private equity firm instead. Azelis is active in a variety of end markets and had 2018 sales of $2.2bn. The company is headquartered in Luxembourg, but is active across NA, EMEA, and APAC.

Management

David Jukes was appointed President and CEO of Univar in 2018. He joined Univar in 2002 and served as COO from May 2017 to May 2018. Additionally, Mr. Jukes held the Executive Vice President and President of Univar USA positions from June 2016 to May 2017. Mr. Jukes is a 35-year veteran of the chemical distribution industry with a distinguished background of achievements. Prior to joining Univar, Mr. Jukes was SVP of Global Sales, Marketing and Industry Relations, for Omnexus, a plastics industry consortium e-commerce platform. In 1991 he joined Ellis & Everard, a chemical distribution company in the UK, ultimately becoming vice president of corporate development for their polymers division. Mr. Jukes is a graduate of the London School of Business.

Jukes was the head of Univar’s EMEA business from 2011-2016. During this period, EBITDA margin for the segment doubled from 3.2% to 6.4%, and EBITDA compounded at ~10% annualized, in the context of weak underlying market growth. The key changes underlying this performance were a re-alignment of sales force incentives and an upgrade to the segment’s ERP and IT systems. In addition to this strong track record, our checks on Jukes from associates of the company have generally been quite positive.

Nick Alexos joined Univar in January 2020 as CFO. Before joining Univar, he served as executive vice president, chief financial officer and chief administrative officer at Dentsply Sirona, Inc. Previously he served as a managing director of Madison Dearborn Partners.

The key metrics in Univar’s annual cash incentive programs are Adjusted EBITDA (75%) and Average Working Capital as a % of sales (25%). The key metrics in Univar’s PRSUs are rolling three-year targets for EBITDA (50%) and ROIC (50%). Additionally, the Adjusted EBITDA portion of the award for 2019-2021 will include a multiplier tied to the amount of synergies captured from the integration of Nexeo.

Collectively, the management and board members of Univar own 2.7mm shares worth $38mm. Notably, insiders have purchased meaningful amounts of stock in recent months, including purchases by Chairman Chris Pappas and CFO Nick Alexos.

Valuation

Univar is currently valued at very modest multiples given the quality of the business, competitive position, and opportunity set. At $15/share, the company trades at ~7x 2019 EBITDA (a 20-30% discount to multiples private equity has paid for the business in the past) and ~9x 2019 P/E (~11x 2019 P/E including amortization of acquired intangibles). The exact magnitude of how negatively the company will be impacted from the current COVID-19 economic downturn is uncertain. However, several factors give us confidence regarding the company’s medium-term prospects:

• All of Univar’s facilities have been deemed essential and remain open for business. While some end markets have clearly been negatively impacted from a demand perspective, others have in fact accelerated.
• Due to working capital and inventory dynamics, free cash flow for the company is very counter-cyclical. It is hard to envision a scenario where the company has negative free cash flow in 2020.
• Leverage and liquidity are in a very manageable position, and covenants for the company are light. The current leverage ratio is 3.7x, which is meaningfully below where Univar operated for many years as a private company. There are no significant maturities until 2024.
• In past downturns, Univar and other chemical distributors have been able to manage costs well and conserve cash. In the 2009 downturn, Univar’s EBITDA declined only 12% from peak to trough.
• Management has moved quickly to put in place cost saving programs over and above those associated with the Nexeo transaction.

(Note: EPS and EBIT metrics in financial summary add back amortization of acquired intangibles.)

Risks

• Economic cyclicality
• Nexeo integration risk
• Salesforce reorganization challenges
• Poor execution relative to competitors
• Leverage (~3.7x LTM EBITDA)
• Consolidation of manufacturers and suppliers

Conclusion

Looking through and beyond the COVID-19 pandemic, we believe that Univar will emerge in a better competitive position due to management’s efforts around salesforce reorganization, merger integration, and ERP implementation while its products and services will be in demand, albeit under pressure during recessionary conditions. We expect that the company’s profitability will exceed 2019 levels as the economy recovers and demand for Univar’s services increases. Assuming a return to normalized multiples, we believe an investment in Univar should compound at a rate in excess of 20% with limited risk over a 3-5 year period.

Appendix: M&A transactions for chemical distributors have been at 8-11x EBITDA multiples

Catalyst

- Economic recovery

- Progress on management initiatives