NGVT - Ingevity Corporation: The Risk To Reward Is Currently Favorable

2023-10-06 13:56:58 ET

Summary

• Ingevity Corporation has seen declines in price due to recent earnings and balance sheet risks.
• Despite the leveraged balance sheet, Ingevity's diversification strategy and undervaluation make it a favorable investment.
• Analysts rate Ingevity as a "buy" with a 55.89% upside potential, indicating a positive risk-reward ratio.
• Assuming my DCF figures, Ingevity is currently undervalued resulting in a buy rating.

Ingevity Corporation ( NGVT ) has seen significant declines in price due to recent earnings and balance sheet risks. I believe that Ingevity is currently a buy because although the firm's balance sheet is rather leveraged, its diversification strategy coupled with undervaluation makes the risk-to-reward favorable.

Business Overview

The production of specialty chemicals and activated carbon products by Ingevity Corporation is their area of expertise. These products are sold throughout North America, Asia Pacific, Europe, the Middle East, Africa, and South America. Performance Materials and Performance Chemicals are the two main divisions through which the business works.

Production of hardwood-based and chemically activated carbon compounds, largely utilized in gasoline vapor emission control systems for various automobiles, is the primary emphasis of the Performance Materials section. These activated carbon products are used in the filtration of chemicals, food, water, and drinks.

Ingevity develops products in the Performance Chemicals division using lignin, cyclohexanone, caprolactone monomers, and derivatives of hydrogen peroxide and crude tall oil. These products are frequently used for building roads, maintaining pavements, providing oil well services, making adhesives, agrochemical dispersants, lubricants, printing inks, industrial intermediates, coatings, resins, elastomers, bioplastics, and medical devices.

Financials

Ingevity's present market capitalization stands at $1.55 billion, showcasing a commendable Return on Invested Capital of 11%. The existing share price is at $42.05, slightly surpassing its 52-week low of $41.48. Worth mentioning is the company's P/E GAAP ratio of 9.04, positioning it below comparable companies, and signaling a state of relative undervaluation.

Although the company does not pay a dividend, Ingevity effectively utilizes its FCF in order to grow its core business by effectively utilizing its 11% ROIC. This will result in greater returns than dividends could provide investors, in my opinion, resulting in a more effective approach. I also believe that the firms' repurchase of outstanding shares is very strong as they have bought these shares back at a cheap share price as displayed in my valuation analysis later in this article.

Earnings

Ingevity reported earnings with non-GAAP EPS beating by $0.03 at $1.41 and revenues missing by $4.74 million at $481.8 showing a 14.7% YoY growth. This demonstrates the firm's ability to maintain profitability during macro headwinds impacting volume demand. With earnings estimates indicating EPS recovery moving into 2024 and 2025, keeping an eye on inflation, as well as volume demand, is needed in order to support this recovery thesis.

Performance Compared to the Broader Market

Over the past 2 years, Ingevity has underperformed the broader market. This is due to a decline in EPS in recent earnings because of macro headwinds and cyclical volume downturns. I believe that with declines being priced in, the risk-reward is now favorable and could result in outperformance in the future.

Analyst Consensus

Analysts in the last 3 months rate Ingevity as a "buy" with a 1Y price target of $65.43 demonstrating a potential 55.89% upside. I believe that analysts' estimates accurately realize the excellent risk-reward Ingevity provides through their optimistic targets.

Balance Sheet

Ingevity's balance sheet is fairly leveraged, which could result in difficulty of taking on more debt. This coupled with macro headwinds such as high rates and a potential income decline could lead to potential solvency troubles in the short term. With debt remaining stagnant, and interest coverage at 4.82, Ingevity will have struggles in improving FCF to foster growth. With a current ratio of 2.46 and an Altman-Z-Score of 2.29, Ingevity should have adequate liquidity to remain solvent in the short term.

Valuation

In order to find an accurate fair value for Ingevity, I must calculate a solid discount rate based on the Cost of Equity using the Capital Asset Pricing Model. Using a risk-free rate of 4.74% based on the 10-year treasury yield, I found a Cost of Equity of 8.91%.

Using the Cost of Equity, I added a risk premium of 2.09% to factor in macro headwinds such as sticky inflation and the firm's rather weak balance sheet moving into a potential recession. Using a 5-year Equity Model DCF via net income, I found a fair value of $53.98 presenting a 21% upside. Regarding my revenue and margin assumptions, I utilized analyst consensus which may be slightly generous, demonstrating why I also added a risk premium.

Product Diversification Resulting in Compounding Growth

The product diversification technique that Ingevity Corporation uses not only expands its product offering but also generates considerable financial gains. Ingevity diversifies its income sources and reduces the risk associated with dependence on a single market by increasing its selection of products and services. Improved financial stability and resilience are frequently the results of this diversification.

Revenue stability is one of the main financial advantages of a broad product portfolio. Market dynamics, demand cycles, and sensitivity to changes in the economy are all different for various items. Ingevity makes sure that even if one industry faces a slowdown, other sectors may stay stable or flourish by providing a wide selection of goods across several industries including automotive, energy, packaging, and construction. Consistent income sources, as a result of this consistency, lower total business risk.

Another key benefit is financial resiliency. With a relatively weak balance sheet, a varied product range will provide a buffer during periods of economic downturn or volatility. Due to income from other areas, the impact on the company's overall financial health in a given market may be less severe.

One instance of Ingevity's product diversification is the addition of cutting-edge activated carbon materials to their Performance Materials section for usage in several applications outside of gasoline vapor emission control systems. For example, they may create and sell activated carbon goods intended to improve the quality of the air and water in industrial settings, expanding their scope of usage to include air and water purification systems used in factories or other industrial settings.

Ingevity can open up new markets, decrease reliance on a particular application (gasoline vapor emission control), and maybe improve income streams by expanding its activated carbon product line to service various industries including the industrial, food, and beverage, sectors. In addition to diversifying their product offering, this strategy presents them as a flexible supplier of activated carbon solutions, making them more appealing to a larger range of clients and sectors.

Risks

Raw Material Price Volatility: Price fluctuations for raw materials like wood-based products and derivatives of crude oil may have a big influence on manufacturing costs, which in turn can have a big impact on Ingevity's profit margins.

Regulatory Compliance and Environmental Risks: As a producer of specialized chemicals, Ingevity must adhere to a number of rules and environmental compliance requirements. Penalties, legal problems, or adjustments to the manufacturing process might result from changes to these laws or non-compliance.

Conclusion

To summarize, I believe that Ingevity is currently a buy because although the firm's balance sheet is rather leveraged, its diversification strategy coupled with undervaluation makes the risk-to-reward favorable.

For further details see: