Third quarter results released today for speciality chemicals maker Croda (LSE: CRDA) saw sales jump a full 20.1% year-on-year to hit £315m. Unfortunately, management was very upfront about the fact that “with over 95% of sales outside the UK, this largely reflected favourable currency translation, with the impact of weaker sterling increasing sales by 17.6%.”
Stripping out the effects of the weaker pound, constant currency sales did rise 2.5% year-on-year due to the positive effects of an acquisition in Croda’s crop care division. However, core underlying sales dropped 2.5% on the back of falling sales of a major generic pharmaceutical ingredient.
Sales compressing is never a good sign and will be worth watching in the coming quarters. But, if underlying sales return to growth then Croda becomes very attractive. A major reason is that the company is well diversified by designing chemicals for everything from haircare, lipstick and sunscreen to seed treatments and environmentally-friendly paint coatings.
Developing and selling these products is also a very capital light business, which produces significant free cash flow. And, a cost-conscious management team and increasing sales of patented products allowed operating margins to improve to 25.7% in H1.
The impressive cash generated by these margins and tight control over capex allow Croda to make targeted acquisitions without resorting to high leverage. At the end of July the company’s net debt-to-EBITDA ratio was only 1.3, a very healthy level for such a cash generative business. This is allowing dividends to increase substantially, although a long rally in share prices means they only yield 2%. Croda is certainly an attractive company, and I believe the shares are worth following in the coming quarters.
Worth a look?
While Croda’s products focus on retail applications, another of the FTSE’s leading industrial firms, Elementis (LSE: ELM), concentrates on industrial applications for oil rigs, cargo ships and construction materials. Elementis has been hit hard by the downturn in the oil & gas industry, with revenue from this key segment down 26% in the first half of the year.
This dramatic fall in sales drove overall group revenue down by 7% year-on-year and led to operating margins collapsing from 19% to 15%. A decrease in oilfield activity isn’t the only headwind facing Elementis as the strong US dollar has negatively impacted sales in its chromium division and forced the company to issue a profit warning in June.
That said, its core business is quite impressive. Its operations still spin off significant cash, which management has no qualms about returning to shareholders due to having no debt. With net cash at the end of June standing at $37.5m, the company was able to maintain interim dividends even as earnings fell.
The twin headwinds facing Elementis, a struggling oil & gas sector and strong US dollar, aren’t about to stop any time soon. However, with a great underlying business, shares trading at a relatively sane level and dividends already yielding 3.3%, now could be the time for contrarian investors to take a closer look.
