Description

(all values in Euros)
A cyclical business emerging from a sizeable restructuring program, not on the radar screens of the investment community, and on a bargain valuation.

Univar is listed on Euronext in the Netherlands, but management is based in the US (West Coast). This means the European analysts don’t cover the business in detail. Management rarely travels to Europe, and updates are rare.

Catalysts
1)Blow-out H1 numbers 27th August.
2)Re-listing in the US, as HAL (46% owner) seek to exit.
3)Potential roadshow in Europe/US post interim results.
4)Expanding analyst coverage in Netherlands.

Valuation – Price Target E28 (+100%)
·Univar is one of the cheapest stocks in Europe, on a 2004 P/E of 6.2x, dropping to 5.1x in 2005. I am not arguing the stock should ever be on a racy multiple, but this is seriously undervalued. Stock is a doubler to 10x, and EPS numbers have plenty of scope to surprise on the upside.
·The company is now entering a phase of reduced capex requirements (guiding for a capex/depreciation ratio of 80%). This leads to a free cash-flow yield of 20% in 2005. Given the working capital intensive nature inherent in a distribution business, this valuation metric should be treated with caution. Univar carried $390m working capital at the end of 2003 (on a market cap of $500m). With the warehouse consolidation there is an opportunity to reduce DSOs to 39-40 days, from 42 currently. The cash opportunity is sizeable, and leaves Univar exposed to a bid, from private equity.
·Balance sheet is sound, and there is ample liquidity. Univar recently refinanced the revolving credit facility at more favourable terms.

·HAL Trust (a Dutch investment company) holds a controlling 46% stake, and sits on the board. They are long-term holders, who have no stated intention to dispose of stock at these levels. However, the lock-up expires in 2005, and they will seek to crystallize value. Most likely solution is a US listing (catalyst for re-rating).

I’m not pretending this is a great business. Chemical distribution has been characterized by overcapacity, intense competition, pricing pressure and a shrinking customer base.

Unlike many distribution businesses, there are few advantages to being large, and national. You need to fulfill the same environmental requirements as your supplier, which means you struggle to be independent. Furthermore, the local players have lower overheads, and historically, a stronger customer focus.

However, the market has consolidated, suppliers are choosing preferred national partners in an effort to reduce logistics and transport costs, and fundamentals are improving.

Share price appreciation will come from multiple expansion and significant upwards earnings revisions.

Conceptually, there is significant operational leverage in the business. Univar managed a 3.5% EBITDA margin in 2003. This means $100m on the top-line (+2.1%) translates to $5.5m on the operating line (+3.5%). Fundamentals are improving, and most analysts haven’t even looked at the stock since March.

Univar targets a 3.5% operating margin, and is moving rapidly towards that goal. ROCE>WACC will happen in the coming years as new management has moved to 166 distribution centres, from 195, and selectively exited unprofitable business.

The company has the tailwind of an improving economy, and the street analysts are way behind the curve on forecasts.

US (50% sales) – saw a revival of activity in late-2003, which has continued into 2004. Firstly, new management have focused on reducing the number of distribution centres to 84, from 120, moving towards a “hub and spoke” system. Secondly, the US business will not carry the $30m additional costs that occurred in 2003 (pension/insurance/strike). This means the operating cost base is coming down in absolute numbers. A 4% improvement in the US top-line (which is conservative, given the discussion below), even with a forecast 30bp decline in gross margin, translates into a 36% EBITA uplift in 2004, and +27% in 2005.

Ashland Specialty Chemicals
·One way to monitor Univar’s likely progress in the US is through the Ashland website. At the end of each month, they publish specific data for the distribution business.
·The top-line trends hide the volume/price mix, which is heavily impacted by hydrocarbon costs (Ashland carries many specialty fuels and industrial chemicals). Univar carries a slightly different product mix to Ashland (more inorganics), but the fact that turnover and gross margin dollars are moving forward substantially implies a strong improvement in H104 for the whole industry.

(% change YoY) Sales/Shipping Day Revenue Gross Profit
Jan +8.6% +3.8% -1.3%
Feb +8.6% +8.7% +5.3%
Mar +8.1% +18.5% +16%
Apr +12.7% +13.0% +9.2%

Europe (34% sales) – has been the problem business for Univar. Grown through acquisitions, the various companies were working off different IT platforms, with different supplies, customers and overlapping distribution capabilities.
·UK (1/3) – has changed the emphasis and is outgrowing the economy, management are optimistic here, as the business has re-focused on growing sectors; food and pharma.
·France (1/3) – was 3 competing businesses, which have been managed through 2003 into one integrated unit. Volume was selectively taken out and although H1 will be disappointing on the top-line, the margins are now on a growth trajectory.
·Other (1/3) – Belgium was losing money after a failed IT implementation (20-25% of sales were lost). At the end of 2003, they moved out of the red. There will be organic expansion in Eastern Europe, and potential in-fill acquisitions (e.g. Italy).
·In local currency, Europe sales will decline in 2004. On a reduced cost base, EBITA can still grow +double-digit%.

Canada (16% sales) – the best business notches up a 5.8% EBITA margin.
·Industrial Chemcials (50%) - On the East coast, the mix is weighted towards general industrial chemicals (grows in-line with US biz). In the West, the company has a strong base in pulp & paper and mining. Margins here a good, but growth is slow, and will likely decline on last year.
·Agriculture (25%) – high market share in agrochemicals and seeds. This is a strong business at the moment (ref: Dow, Monsanto, DuPont, BASF, Bayer, Syngenta).
·Oil & Gas (25%) – benefits from heavy chemical usage of the industry, and Univar have an integrated hub and spoke distribution structure. Strong season (Jan-Apr) was up YoY.

Bain acquisition of Brenntag.
·In December, Bain Capital acquired Brenntag (Top-3 global distributor, with strong presence in Germany) from Deutsche Bahn. They beat CVC Capital Partners to win the bid. Brenntag registered E4.3bn sales and E241m EBITDA in 2003.
·E1.4bn price represented a takeover multiple of 0.32x Price/Sales and 5.8x EBITDA.
·Implied take-out price on Univar (2003 numbers) would be E27 on EV/Sales (after deducting $357m net debt, $130m under-funded pension scheme and $70m environmental provisions).
·Looking at 2004 numbers, when we see the EBITDA improvement fuelled by recovering manufacturing sector, and internal measures. 5.8x EV/EBITDA would equate to a price of E19 (after deducting prospective $310m net debt, $130m pension, $70m environmental provisions).

Catalyst

1)Blow-out H1 numbers 27th August.
2)Re-listing in the US, as HAL (46% owner) seek to exit.
3)Potential roadshow in Europe/US post interim results.
4)Expanding analyst coverage in Netherlands.