Shares in global chemicals specialist Elementis (LON:ELM) fell around 15% in early trade today as a full-year update revealed some demand slippage at the end of the year and a reduction in profits as a result. The latest Elementis profit warning takes over £100m off the market cap:
It is fair to say the share price has seen better days. 2019 has seen the price rise and fall without any specific trend. Longer-term, the trend is downwards. Two years ago the share price was almost double the levels that we are seeing now.
Elementis has a long and distinguished history, dating back to the 1800s as tea and coffee traders, expanding into other trades by acquisitions of other companies. More recently the company has specialised in chemicals, for both industry and chemical use.
What’s gone wrong at Elementis?
The Elementis profit warning comes in a trading update which covers the period of 12 months to 31 December 2019. We get into it straightaway:
Trading in the final quarter of the year has been somewhat subdued and as a result adjusted operating profit for 2019 is anticipated to be $122-124m.
The figure for 2018 was $133m which gave a PBT of $65m. No figures are given as to what previous guidance was, but the share price implies a slight miss.
In line with previous updates, each of the operating segments (Personal Care, Coatings, Talc, Chromium, Energy) got an update, and it was the latter two which fared worst, citing decreased demand and industry slowdown. Thankfully, these are relatively smaller segments.
Their goals are clear at present:
We remain committed to delivering our medium term Group performance objectives of a 17% operating profit margin, operating cash conversion of at least 90% per annum and financial leverage of under 1.5x EBITDA, with further reduction thereafter.”
Elementis: All change
The figures from Elementis could be said to be rather flat looking:
But this covers up that there has been huge changes in recent years. There have been a couple of huge acquisitions: SummitReheis (an antiperspirant specialist) and Mondo Minerals (a talc specialist) have come under the Elementis brand in recent years while the Surfectants division was sold off.
The acquisitions hugely outweighed the sale of businesses: the combined price for these two acquisitions was almost $900m, almost all of the current market cap so it is clear that these should be transformational. On the financial side, it has been. The new companies were paid for by a rights issue and debt: the company has changed from one that has had net cash to one that that had net debt of nearly $500m in the last financial report.
On the flip side, the business is positive and seemingly has some great attributes if it can perform in line with expectations. Operating margins of 17% appear sustainable (as lower margin businesses have gone). The cash conversion also appears very high:
Both of these aspects suggest that their products have some kind of essential role to play in the manufacture of others. The current picture does not suggest any immediate danger. Elementis is also extremely well diversified globally: just $32.1m of revenues come from the UK with North America ($290m), Europe ($201m) and the Rest of the World ($299m) being where it is at.
More interesting is the toll these acquisitions have taken on the balance sheet. Clearly there are a lot of depreciation charges to be thrown in. The net tangible asset position is negative at present, thanks to large goodwill and intangible balances. But the business appears heavily liquid. Current liabilities were $167.9m matched by current assets of $429.2m, and almost $100m of this was cash.
The longer-term liabilities are more relevant here. There was $594.2m of bank loans (maturing after 5 years) at an interest rate of 3.7%. The finance cost of almost $20m in the past year reflects the fact that this is a significant cost. And whilst it is the case that Elementis is a cash-converting machine, there are other elements that come into play. Capital expenditures are significant and topped $50m last year. Dividends also cost over $40m. This itself was cut to 2.7c from 7.9c and is a sensible enough measure while attempting to reduce leverage.
Are Elementis shares good value?
There seems to have been a big about-turn in this British company. Previously it was a low-risk, conservatively run group of businesses on a known strategy, paying out half of its free cashflows as dividend whilst still accruing cash itself. Since the new CEO took over in 2016 this has all changed and the company has made some bold plays and acquired others. Now the group has a large net debt and an uncertain dividend, but perhaps a new platform for some growth. The Elementis profit warning forces us to consider the balance between risk and reward.
Debt always adds more uncertainty to the mix. On current cashflow, it does not appear possible that the loans will be paid off by the fifth year in which they fall due, but refinance is always an option. The more relevant question may be, is how much will the new acquisitions contribute to the company? Broker forecasts show that they will be significant and 2021 may show $90m of net profits. Considering the levels of depreciation shown here this may be some 20-30% greater than the comparable adjusted profit figure today.
For those with confidence that Elementis will perform to expectations there could be an argument that the share is priced keenly: an implied forward earnings multiple of 13 is not high for a business that can take opportunities all around the world. I would be a little more bearish and think it looks fairly priced about now, but improving the debt load would offer some clear runway for the share price to improve. 3/5.