All eyes are on Croda International. The speciality chemicals business, long regarded as one of Britain’s best companies and a perfect buy-and-hold-on-to-for-life investment, has a bright future yet was one of the worst performers in the FTSE 100 last year and has more than halved in value since the end of 2021. You might assume that now is a good time to buy. Sadly, it isn’t that simple. Sharp sell-offs do not necessarily lead to attractive valuations.
Croda’s unique concoctions improve the quality and performance of everything from skin cream, suntan lotion, shampoo and television screens to crops, drugs and vaccines. They also, unlike some of the competition, happen to be created mainly from natural materials.
Companies worldwide are reliant on Croda’s special ingredients. Without them, their products lose their edge. That generally translates into robust demand, strong pricing power, wide operating margins and a premium valuation — the hallmarks of a high-quality business.
Ironically, the FTSE 100 chemicals maker became a victim of its own success. Croda was a big beneficiary of the global pandemic. It made the lipids that helped the Pfizer-BioNTech Covid vaccine to reach the right cells in the body. Then, when the world was emerging from lockdowns and supply chains started wobbling, pretty much all the company’s vast customer base aggressively built up stock in anticipation of a surge in orders.
The huge amount of growth reported in this period wasn’t sustainable and the landing was a hard one. Appetite for Covid jabs disappeared, inflation rose sharply, consumer budgets became squeezed and buyers of Croda’s products, fresh from engaging in an unusual amount of hoarding, discovered they had ordered way too much.
Demand went from one extreme to the other and the company’s financials got hammered. Sales volumes plummeted, margins were squeezed and its management struggled to see it all coming, issuing two profit warnings in the space of five months.
Investors are now trying to figure out when business will return to normal. A full recovery in 2024 seems unlikely, but there are signs that some of the biggest challenges are easing. In the past few days, a handful of Croda’s international peers reported a rise in orders and an end to the destocking cycle. This is raising hopes that an inflection point has been reached and that bad news and nasty upsets might be a thing of the past.
The shares certainly scream optimism. Despite falling substantially over recent years, they still trade at 30 times forecast earnings. Croda has never been a cheap stock, but that’s even more expensive than usual.
There are several factors that could help to prop up the shares and support a premium rating. Interest rates appear to have peaked, demand is poised to return, the balance sheet is in great shape and there is no shortage of long-term growth drivers.
Croda is well positioned to profit from various so-called megatrends, including better drug efficiency, the risk of more pandemics, rising wealth in Asia, a fear of ageing and wanting to look younger, using ethical and natural sources and feeding a growing population. Its reputation for being well-run and ability to cater to many of the world’s biggest needs and desires explain why the chemicals maker continues to command a high price-to-earnings ratio.
Good-quality companies tapped into growth markets always tend to fetch a premium. And sometimes it isn’t merited. Croda isn’t about to start generating the type of profit growth normally associated with price-to-earnings ratios in the high 20s to low 30s. The next few years will be challenging and expectations perhaps need to be dialled back a bit.
This is a company that ticks a lot of the right boxes, but the present asking price is a bit too steep.
Advice Avoid
Why The shares are not as cheap as they might first appear
AG Barr
AG Barr is on a mission to prove its doubters wrong and win back the confidence of investors. Yesterday’s trading update brought it another step closer to achieving that tricky task.
The group behind Irn-Bru, Funkin, Rio, KA and several other well-known drink brands used to be considered a top stock in the popular beverages sector. Then profits started to fall and investors began fretting about its lack of exposure to growing segments of the market and a generally quite slim and sugary portfolio.
AG Barr now seems to be on the mend and more in touch with current trends. In the year to January 28, it reckons revenues climbed by 26 per cent, or 8 per cent on a like-for-like basis, and that profits grew by about 14 per cent, which is slightly better than the market had expected. Those numbers are comforting, especially considering the wetter-than-average summer and rising costs, and serve as a reminder of the popularity of AG Barr’s products with customers.
Comments about cost inflation normalising and the operating margin improvement programme being on track were also welcomed. Boost, which positions AG Barr in the fast-growing energy drinks market, was a smart acquisition, but it came with the caveat of thin margins. Measures to bring its returns in line with the rest of the business and cheaper expenses should help to provide further profit growth in the year ahead.
Positive brand momentum and margin recovery have boosted sentiment and pushed the forward earnings multiple up to 18 times. To rise further, other uncertainties might need addressing. They include whether oat milk can produce decent profits, the impact of the delayed deposit return scheme in Scotland and how the group will be run in the future. AG Barr released its trading update alongside the surprising announcement that Euan Sutherland had been chosen to take over from Roger White. Sutherland has bags of experience, having run the likes of Saga, Superdry and the Co-op, but White was a popular figure and could be a tough act to follow.
Advice Hold
Why The shares are fairly priced