BNTGF - Brenntag Is Definitely Undervalued Here - It's A 'Buy'

2023-03-21 02:05:58 ET

Summary

• With everything that's going on, I don't have much time to introduce new companies to you here in SA - not that often at least. So I pick carefully.
• Brenntag is a company I've been following since the COVID-19 crash. I did not invest, unfortunately, but I "knew" that it would go back down.
• And now - it's on my "BUY" list - here is why.

Dear readers/followers,

I'm going to introduce you to a "new" company on my coverage spectrum today. This is rare, especially in this current environment where I'm mostly focusing on "handling" my existing positions and portfolios, updating theses, and showing you where I believe things are going.

Well, I believe now is a decent time to introduce you to Brenntag ( OTCPK:BNTGF ) ( OTCPK:BNTGY ). It's a German company, and Germany has a lot of industrials and related businesses in the sector. Brenntag is one of them. In this article, we'll look at fundamentals, and prospects and give the company a valuation to work with. I'll also show you why despite forecasting earnings drop this year, I actually consider Brenntag to be a "BUY".

Let's get going.

Brenntag SE - Distribution in key sectors

So, Brenntag is a pretty interesting company with a fairly interesting history (and quirky as well). The company, where the name by the way means "Burn Day/Burning day" directly translated, was founded as early as 1875 by a German out of Berlin. The company he founded was an egg wholesale business.

The company is a chemical distributor. It entered this business about 40 years after its founding back in 1912. The company is headquartered in Essen, manages over €14B in revenues, and employs over 15,000 people. It's represented in 700 locations across the globe and began expanding globally in the mid-60s and 80s, predominantly. Brenntag has grown both through inorganic and organic growth, and its international expansion has been predominantly inorganic, by acquiring suitable distribution businesses and forming JVs.

Back in the early 2000s, Brenntag bought Holland Chemical International, which was the fifth-largest chemical distributor in the world. This caused the company to gain market exposure to most of Scandinavia and Eastern Europe as well as the USA and become a market leader in LATAM.

Since then, the company has only grown.

It's fair to say that Brenntag is a chemical distribution leader, which has mostly ignored any and all downturns in terms of its gross operating profit.

That is the reason I had my eyes opened to the company years ago. It's stellar and unchanging performance, seemingly no matter what is thrown at the company.

The company's operating structure is made of two global divisions focusing on two specific areas - essentials and specialties. The Essentials business is larger in terms of profit and revenues, but each of the segments and products has its applications and appeal.

No other company is global in both of these segments. The company is an undisputed market leader in both segments for both 2021 and beyond. The closest competitor for both would be Univar, but aside from that, no other company even cracks the top three for "both" of these segments. It's diversification and management of application laboratories combined with the appeal of its essentials business makes Brenntag the most successful and largest specialties and essentials distributor with a global as well as local reach.

This has resulted in an operating EBITDA CAGR of 9% since the financial crisis.

A chemical distributor like Brenntag works in a value chain where they act as a Value-adder. The company works with suppliers, storage solutions, transport/logistical solutions, packing/labeling/bar-coding, bundling, vendor-managed inventories, mixing/blending/formulating, and everything within the value chain.

It pays to understand both what Brenntag is and what it is not.

I own plenty of chemical production companies, such as BASF ( OTCQX:BASFY ) and Evonik ( OTCPK:EVKIY ). That is what Brenntag is not. Chemical production companies have a manufacturing business model with typically narrow product portfolios, customer basis, and large-scale order sizes that are delivered by the truckload.

Their business models, if you like me spend hours poring over financial reports, contain significant high-intensity fixed assets with a narrow purpose, offering very little flexibility to the business model. Cost bases are fixed, and their raw material prices are contract-based, with what is known in the industry as "disconnected" pricing to the input/output calculation.

Brenntag is the exact opposite to most of these.

It has a B2B services and solutions business model with a very wide product portfolio, its customer is typically much smaller - you can buy a box of chemicals, and at less than a truckload. Much of its assets are multi-purpose flexible assets that can be purposed to the need at hand, and it works at a variable, connected pricing and cost base with a market/spot pricing method for its products. This allows Brenntag to be more flexible, and this business model is more agile in adapting to changing conditions.

I'm very clear here that neither insulates the companies in question from volatility - which we'll see - but Brenntag has some advantages in a situation like the one today.

The company buys its product from a wide variety of suppliers globally...

...and industry trends are pointing towards specialties and a portfolio focus to decrease the cost of fixed assets - becoming a master of one, instead of a master of none. This opens the market to distributors like Brenntag. This also comes at an incredible sort of moat, because even being a distributor like this company requires substantial assets and infrastructure that is not in any way easily replicated. Both of these markets we're talking about have a combined TAM of nearly €300B per year, and these markets, unlike some, are expected to grow at 2-7% in the next 2-4 years per year.

Its partners are highly attractive businesses with good futures, both near- and longer-term.

The company is partnering on a global basis with excellent suppliers and customers both and acts as an intermediate between the two. Even the lower-growth areas for things like essentials are expected to grow at a medium pace going forward. Take a look at the profit mix in terms of a few different variables here.

The company manages over 13,5M transactions with 180,000+ customers, and the company is even on track to become an ESG leader, with AA rating from MSCI, a Platinum rating from EcoVadis and other organizations - for those interested in such data points/variables (I am not, but I know many who are).

The company's ambitions is to continue to be an active M&A'er going forward and continue to grow inorganically as part of its strategy, with 300 potential takeover targets currently in "mind" for the company, at an annual spending rate of €400-€500M.

Targets for 2026E are as follows.

Brenntag is an industry leader. It has two distinct and excellent market offerings in terms of the segment. Its product portfolio compared to other competitors is larger, and "better" (in terms of efficiency), it's a trusted global partner with decades of customer relationships in the bag, and it's a leading consolidator in the fragmented market of chemical distribution.

For my own goals, it's very logical to add Brenntag to my portfolio, given that I am a heavy investor in the chemical industry. If, of course, want to buy the company at a price I can swallow as "attractive", and for the past few years, this has not really been possible.

Let me show you why I believe that is about to change.

Brenntag's Valuation - The company has a significant upside here to new normalized earnings levels

Brenntag, like many companies across a multitude of sectors, saw increased revenues and earnings in the latest few years. The company has been able to average a growth rate of almost 11% per year since 2011 when looking at earnings. This has driven the company's valuation up. Brenntag stock typically trades at a range of 15-18.5x P/E, sometimes dropping below that, and sometimes well below that.

During the COVID-19 crash, you could pick up Brenntag for as little as 11x P/E - I did not, unfortunately - though it would have been very profitable venture to do so.

The main question on investors' minds today is how reliable and sustainable those increased earnings levels are. To which, I say that they seem, based on company and macro trends, to be relatively sustainable, and no drop is expected in the next few years, beyond 2025E as well.

Earnings and dividends are set to slowly grow. The current yield is over 3%, which isn't as much as chemical production, but earnings are more stable and forecastable, even if the share price and valuation clearly is anything but. My own estimates call for growth rate of at least 4-5% for the company going forward, which would actually be below where the company has typically averaged over time.

I'm careful giving the company an 18x P/E or above because given the new earnings norm, this would imply a far-changed share price based on what we've seen before. Instead, I choose to forecast it around 14-15x P/E, which I believe gives us the conservative perspective on Brenntag that we might want to be looking for.

However, even at a 14.45x P/E on a forward basis, Brenntag has the possibility of generating double-digit returns of 15% annually and above.

And that is, as I said, the conservative case. In the case of base, or bullish, I could see at least 15-16x P/E becoming realistic here, and a full normalization to 18x brings with it no less than 25% per year, or 85% until 2025E, which is significantly market-beating.

Peers to Brenntag do exist. You could look at Axcelis, Univar, Travis Perkins, INCD, Rexel, and others - however, Brenntag in terms of revenues and EBITDA, is either fairly valued to most of these, or undervalued to most of them in terms of P/E. The current normalized P/E is no higher than 11.8x no matter how you look at things, and its competitors trade at ranges from 12-20x. Also, Brenntag is bigger and has better economies of scale than almost all of these competitors, and in terms of pure size, only trading companies like Ferguson PLC come even close to beating Brenntag's even-depressed €10B market cap.

DCF is also conservative. A conservative DCF based on EPS growth of 4-5% with a discount of 10-11% gives us an upside of at least 10% to a range of €75-€79/share. Analysts following the stock go even higher. As far as those analysts, go, 17 of them follow Brenntag and 13 of them are "BUY" or equivalent , with a range from €73/share to €100/share, and an average of no less than €87.

I will continue to take a conservative stance on any investment I make. In this case, that means Forecasting Brenntag at a compressed 12x P/E valuation (yes, despite what I said earlier), and discounting the company's potential earnings by 15-20%, which results in a 12x 2025E P/E price target of €75/share.

I want to emphasize how much I am discounting, being conservative and really going all out to push the target down here. I want to stay realistic - and I don't see the possibility to go any lower than this target and stay realistic.

So, for that reason, this is my thesis on Brenntag as I am starting my coverage here.

Thesis

• Brenntag is a world leader in chemical distribution. No other player offers the same sort of diversity of operations and products and is as well-integrated as Brenntag. The company is an excellent complementary investment to a basic materials portfolio, and at the right price, should be considered a must-own due to double-digit return potential based on extremely attractive exposures and trends as we move forward.
• I give Brenntag a conservative PT of €75/share. That's as low as I can go, and that's with impairing earnings 15-20% and going as low as 12x P/E on a forward basis, despite believing that the company is really worth 14-15x P/E, implying a share price close to triple digits.
• For now, I rate Brenntag as a "BUY", and I will be initiating a position in the company come next week when the market opens.

Remember, I'm all about:

1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them ( italicized ).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

This means that the company fulfills every single one of my criteria, making it relatively clear why I view it as a "BUY" here.

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