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The stock is cheap compared to peers but analysts think earnings could recover rapidly and ‘positively surprise’ the market
Thursday 18 Feb 2021 Author: Mark Gardner

FTSE 250 chemicals firm Elementis (ELM) ticks all the boxes for an investor looking for an overlooked and undervalued stock set to benefit from the reopening of society and the economy.

Elementis has the right mix of sales divisions to benefit from both economic activity picking up again and society reopening, and at a bargain price-to-book value of just 1.2 times, compared to a much higher 9.45 times for peers like Croda International (CRDA), we believe the firm has been unfairly overlooked by the market.


Elementis’ four main divisions are Personal Care (chemicals for deodorants, soap, skin care products, etc), Coatings (used for the industrial and construction sectors), Talc (used in paper, paint, plastics, polyester, ceramics and even food) and Chromium, with 80% of its earnings now coming from the first three aforementioned divisions according to its 2019 annual report.

Berenberg analyst Sebastien Bray says Elementis has been marked down by the market in the past over its Chromium division, with chromium prices generally having been weak for years.

Bray says analysts ‘have spent so much of the past five years cutting numbers for this segment that we suspect many are instinctively reluctant to model a return of pricing growth and operating leverage, even if all macro indicators suggest this could emerge from H2 2021’.


He thinks close to 50% of Elementis’ earnings in 2020 will likely come from coatings – an industry that has been quick to recover from the coronavirus crisis, and argues that Elementis trades cheaply versus peers because of this. He also points out the balance of supply and demand in talc may also tighten long term, which could add more than 10% to the firm’s earnings before interest and taxes.

This viewed is echoed by analysts at Morgan Stanley, who think the strength and speed of Elementis’ earnings recovery in 2021 could ‘positively surprise, given the company’s gearing to cyclical end markets (c.55% of sales), as well as the reopening trade (15-20% of sales)’.

Meanwhile both Bray and analysts at Morgan Stanley sees the firm’s deleveraging story as potentially adding to the share price.

Morgan Stanley analysts believe management’s continuing delivery on its objective to pay down debt could add ‘5% to equity value per year’, while Bray says the dividend cut and covenant extension in 2020 have ‘removed immediate danger and that the business’s high levels of cash generation should drive leverage down thereafter’.

The firm’s net debt in recent years has ballooned to almost $500 million, compared to a net cash position of $77.5 million in 2016, something which has also weighed on its share price.


But the company said in September it was on track to deliver a ‘significant’ reduction in net debt in the second half of 2020. That and the fact net debt remained at the same level in the first half of 2020 as the same period in 2019 has led analysts at Jefferies to estimate net debt could be cut by $45 million in the second half of 2020.

Relative weakness in the company’s share price has also seen it become a takeover target, with US rival Mineral Technologies seeing three offers, the last worth 130p per share, rejected with Elementis arguing the offers ‘significantly undervalued’ the business and ignored the firm’s ‘clear strategy to create value for its shareholders’.

Detailing the reasons why it thinks it is worth 200p per share when it rejected the last takeover offer in December, Elementis points to the fact it is the owner of ‘differentiated resources with high scarcity value’, including the world’s only commercially viable high-quality rheology grade hectorite mine.

It also highlights the fact over 80% of earnings are now from Personal Care, Coatings and Talc, which benefit from ‘fundamentally attractive’ margins and GDP growth, with the divisions achieving an average adjusted operating profit margin of around 15% over the last three years, with its medium term group adjusted operating profit margin objective being 17%.

Elementis also argues that specialty chemicals companies with margins in the range of 14% to 17% currently trade at 17 times to 19 times 2021 EV/EBITA (enterprise value to earnings before interest, tax and amortisation), and that applying this range to average operating profit for the Personal Care, Coatings and Talc businesses over the last three years implies a valuation of 163p to 190p per Elementis share.

The company adds that this excludes its Chromium business, which could be valued at an additional 35p per share, implying a group valuation of 200p or more per share as the firm ‘delivers on its medium term objectives’.

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