Croda International‘s (LSE:CRDA) one of my favourite UK shares. I think the FTSE 100 chemicals firm is an extremely high-quality business.
Better yet, the company’s share price has fallen 26% over the last 12 months. With the stock back where it was in 2017, I think it’s worth serious attention.
A quality operation
In my view, Croda has a lot of the hallmarks of a quality business. One of the most obvious indications is its dividend, which has increased every year for over three decades.
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Croda International Dividends per share 2014-24
Created at TradingView
That’s often a sign of a durable business, but it’s also worth noting that the firm only distributes around 50% of its earnings. The rest gets reinvested for growth.
Importantly, Croda’s been reinvesting its earnings at impressive rates of return. Over the last decade, the company’s consistently achieved strong returns on equity (ROE).
Croda International ROE 2014-24
Created at TradingView
Arguably, this is even more significant than dividend growth. It indicates the business still has opportunities to grow.
Barriers to entry
Impressive metrics are important. But a long-term investment also needs something that’s hard for other companies to compete against, so it can keep generating strong returns.
In my view, Croda’s business has some of the best protection in the FTSE 100. Some of this comes from patents which makes it impossible for competitors to replicate.
In other cases, its distribution systems are also specified by drug companies as part of the approval process. That means manufacturers have no choice but to use its products.
This gives Croda significant pricing power. And it’s why the business has been able to achieve such strong returns while distributing more and more to shareholders.
Short-term headwinds
This is why Croda’s one of my favourite UK stocks. The business is also extremely difficult to disrupt, which allows it to reinvest at high rates of return while growing its dividend.
Despite this, the stock’s down 61% from its December 2021 levels. This is due to declining Covid-19 vaccine sales, which had provided a big boost to both sales and profits at the time.
As a result, Croda’s ROE has fallen away over the last year or so. And investors need to think carefully about what the company’s bottom line will look like when things normalise.
In 2023, the business generated £149m in free cash flow. That amounts to a 2.6% return on a market-cap of £5.6bn, so the current share price implies an expectation of future growth.
Should I buy the stock?
Buying shares in quality companies when they trade at bargain prices is what I look to do with my investing. But I’m not quite sure Croda fits the bill at the moment.
In its best year, Croda generated £189m in free cash. At today’s prices, that implies a 3.3% annual return, which isn’t enough to get me excited from an investment perspective.
Earnings are likely to be higher in the future than they have been lately. But the company’s going to need to make more than it did when demand surged during the pandemic.
That seems like a high expectation to me. As a result, even with the stock back at its 2017 levels, it doesn’t offer the margin of safety I look for in an investment.
