Constituents of the UK chemicals sector span both a wide range of market capitalisations and end markets.

These include aerospace, automotive, coatings, semiconductors, sports and leisure and the global flavour and fragrance industries. The largest company in the UK chemicals sector, Croda (CRDA) has a market capitalization of £12.6 billion, this contrasts with AIM-quoted Biome Technologies (BIOM:AIM), the smallest company in the sector that has a market value of just £14 million.

For this universe of stocks, we believe Synthomer (SYNT) and Croda (CRDA) are the most attractive plays with exciting growth stories investors should look to get involved in.

Both companies have benefited significantly from the Covid pandemic, albeit in very different ways and we think the advances they have made will outlast the pandemic.

Synthomer has seen continued high demand for nitrile gloves, which are used extensively in hospitals and other segments of the medical sector, due to their high strength and superior puncture resistance.

Croda supplies lipids for one of the most exciting areas of modern medicine being mRNA technology. There is considerable growth opportunity in lipid systems as adoption widens from Covid-19 to other vaccine and gene therapies.

Main market constituents of the UK chemicals sector

Croda (CRDA)

Market cap: £12.8 billion
Share price: £91.87

Elementis (ELM)

Market cap: £855 million
Share price: 147p

Johnson Matthey (JMAT)

Market cap: £5.75 billion
Share price: £29.75

Synthomer (SYNT)

Market cap: £2.3 billion
Share price: 543p

Victrex (VCT)

Market cap: £2.3 billion
Share price: £26.73

Treatt (TET)

Market cap: £671 million
Share price: £11.26

Zotefoams (ZTF)

Market cap: £220 million
Share price: 453p

A QUALITY SECTOR

Chemicals companies are often perceived as having their fortunes tied to the economy and movements in commodity prices which affect their input costs. However, most of the UK-listed contingent operate and, in some cases, specific market niches which means they are effectively ‘speciality’ chemical firms.

This means for the most part they are higher margin, cash generative and less at the mercy of fluctuations in domestic, regional and global GDP. Their performance has been strong with the FTSE 350 Chemicals index comfortably outperforming the wider market.

This is less the case for the smaller chemicals firms on AIM, the majority of which are not yet profitable and are therefore more speculative plays.

This also means they trade at premium valuations. Based on forecast data from SharePad the average price to earnings ratio for the sector based on the latest reported numbers is 35. However, in the case of Synthomer and Croda we think their valuations are more than justified by the potential on offer.

The market has repeatedly underestimated Synthomer’s ability to deliver earnings growth ahead of expectations.

On 19 July Synthomer raised its 2021 EBITDA (earnings before interest, tax, depreciation and amortisation) guidance to above £500 million from previously above £450 million.

Synthomer (SYNT) 543p

What it does: Synthomer is a UK listed specialty chemicals company with four divisions. 

Performance Elastomers supplies nitrile latex to glove manufacturers and styrene butadiene into paper, foam and carpet applications. 

Functional Solutions supplies aqueous polymers into coatings, adhesives, construction and technical textiles. 

Industrial specialties supplies specialty chemicals and additives into PVC and polymer manufacture, construction, and automotive applications. 

Acrylate monomers supplies acrylate monomers to the Functional Solutions segment and external customers.

Significantly this marked the fourth successive earnings upgrade. There are three reasons to believe that the group will continue to benefit from super normal profits from its nitrile production.

First, there will continued strong demand from the direct and indirect impacts emanating from the pandemic, as healthcare workers demand greater protection.

Second, longer-term nitrile margins are likely to remain robust, even if they drop a little from the peak levels associated with the pandemic. According to Canaccord Genuity unit margins in nitrile that have averaged €150-€230 per tonne on an EBITDA basis over the past eight years will peak about €600 a tonne this year before moving back to €240 by 2024.

Third, the nitrile market is evolving into a duopoly market structure with production being dominated by Synthomer and South Korean multinational chemicals company Kumho Petrochemical. Moreover the nitrile market is considerably larger which will mitigate the impact of incremental capacity increases.

Recent earnings upgrades have been broad-based and have included not only nitrile (gloves), but also sales into paints and coatings. Moving forward the rest of the group is likely to benefit from the strong demand from coatings, DIY and the coatings market.

M&A OPPORTUNITY.

Synthomer has £1 billion of potential firepower excluding equity issuance. The new incoming CEO Michael Willome has a good track record of M&A at Swiss industrial conglomerate Conzetta. Management have repeatedly highlighted acquisitions as a means of creating value. The balance sheet looks in good shape with a net debt to EBITDA ratio of just 0.4 times so there is clearly scope for further deals in the future.

VALUATION

Synthomer is inexpensive trading on a 2021 enterprise value (EV) to EBITDA of 6.1 times versus peers and specialty chemicals at 9.3 times EV/EBITDA. The group has a strong free cash flow yield of 14.7% for 2021, versus 6.3% for cyclical chemical peers. It is worth bearing in mind that Synthomer’s valuation looks very cheap based on forecasts for the current year because of the strong nitrile demand which most analysts are forecasting to moderate in 2022 and beyond as we emerge from the pandemic.

There are a finite number of companies worldwide that are able to produce custom lipids (lipids are molecules that contain hydrocarbons that make up the building blocks of the structure and function of living cells), in significant quantities and which conform to the high quality requirements outlined for vaccine production.

CRODA (CRDA) £91.78

What it does: Leading supplier of chemicals based on natural ingredients.Major supplier of ingredients for the beauty-care, homecare, healthcare and industrial markets. Key company characteristics are the large number of products, and the wide spread of customers. The company
has a preference for direct sales rather than using distributors and there is a wide employee ownership of the company shares.

Acrylate monomers supplies acrylate monomers to the Functional Solutions segment and external customers.

LIFE SCIENCE POTENTIAL

Only four major CDMO’s (contract development and manufacturing operations), currently produce lipids used in the Pfizer/Biotech and Moderna Covid 19 vaccine.

Pfizer has a five year non-exclusive supply agreement for lipid systems with Croda. In response to robust demand the group is making significant investments in its lipid production capacity. It intends to double the capacity of its American site, while quadrupling the capacity of its UK site. Croda have emphasised that they don’t regard competition within lipid production as a significant threat, given that the industry is very much in its infancy.

A GAME CHANGING OPPORTUNITY

After a decade of research mRna technology can unleash the immune system’s ability to fight disease to an unprecedented extent. The human body uses mRna code carrying molecules made naturally in our cells to produce the instructions for life. By harvesting mRna it is possible to teach cells to make the proteins to fight disease.

The trick is getting the instructions into the cells, because as incredible as these messages are they are also incredibly delicate. The breakthrough needed was the development of Lipid Nanoparticles. LNPs or lipid nanoparticles are tiny fatty droplets that carry mRNA safely like a shipping container, only one hundred thousandth of a centimetre in size, and surrounds mRNA forming a protective shell for their journey to our cells. As soon as LNP accomplish their mission they dissolve and disappear.

Croda has emphasised that it is involved in 60 other projects that focused on Covid 19 vaccine and therapeutic treatments. Croda is supporting 25 Covid-19 projects in relation to lipid systems.

Overall there are over 200 lipid products that are in Phase 1, 2 or 3 clinical trials, the majority of which relate to oncology drugs. The pipeline of mRNA therapeutics in clinical trial address a wide number of indications including Alzheimer’s disease, Parkinson’s disease, cystic fibrosis and diabetes.

VALUATION IS REASSURINGLY EXPENSIVE

Croda is far from cheap, trading on a 2021 EV/EBITDA of 21.4 times, an all-time absolute valuation high. However there have been a series of recent broker earnings upgrades. These have been predicated on two factors. First, further reopening and margin upside in Consumer Care. Second, further upside in Life Sciences from both Covid and non-Covid opportunities in patient health.

Liberum chemicals analyst Adam Collins recently increased his 2021 earnings forecast by 20%, as well as ‘outer year forecasts in Life Sciences’.

‹ Previous2021-09-02Next ›