Brenntag: ‘Hold’ Was The Right Choice – But Now We Have Upside (Rating Upgrade) (BNTGF)

Dear readers/followers,

Brenntag (OTCPK:BNTGF) (OTCPK:BNTGY) is a chemical distribution company with a very strong set of fundamentals, one of the better business models in this entire sector (given mix and operations), and one that I in previous articles have termed “antifragile”, among other times in articles like this one, my last coverage on the company.

But as you can see if you follow the link, in my last piece on Brenntag, I actually “took home” some of my profits following a peak in the business, and changed my rating to “Hold”. This proved to be entirely the right way to go for Brenntag, as the company has dropped over 20% even with the dividend included since then, compared to an S&P500 which is up double digits.

Prior to that one, I wrote two bullish articles on the business – and I’ll give you a sneak peek and say that in this article I’m going back to considering the company to be a “Buy”.

Brenntag is an excellent example of why valuation remains the key me to investing profitably. I’m not going to say that Brenntag was massively overvalued when I sold it because it wasn’t. But it was certainly up there for a company expected to go negative in terms of EPS growth this year (and it still is).

Now, however, let’s see where things take us.

Brenntag – The company’s upside at below 14x P/E is compelling

When I last wrote about Brenntag, we were talking about a 16x+ P/E with a sub-3% yield at a questionable upside with plenty of volatility. That volatility in the company’s end markets is still there, but what has changed is the company’s valuation, yield, and even the company’s upside. We’re now at 3.27%, and the company still is BBB+ rated. It’s also a business that, even with the drop in earnings, is expected to at this time generate upwards of 9% CAGR in EPS going forward as well.

And that’s what we’ll look at. The company’s 2Q24 results were published in mid-August, which makes them less than a month old at the time of writing this article. That doesn’t make them any better – but I also didn’t expect all that much, given that we’re expecting EPS declines this year. The company’s sales continued to decline, with a 2% decline to previous year results, and a small 0.6% growth in operating profit. However, EBITA was down 10%+, FCF was down over 63%, EPS was down over 15%, and the company characterizes the company’s business environment as one of “intense competition” – a fair assessment here.

The company also confirms an operating EBITA, that based on some line items and adjustments, would put adjusted EPS at more or less the same level as last year, with maybe a percentage point drop or so.

What positives do we have to count on from Brenntag here?

Brenntag has been clear that it seeks to improve its strategic initiatives and thereby its overall bottom line. The company has been doing several M&As, 5 in total as of 2024 2Q24, and other measures are on track as well.

The drops in operating results were primarily due to significant organic decline, meaning volume/pricing decline due to intense competition – and the declines came from both the specialties and the essentials segment, neither of which did well. Specialties saw declines both from life and material sciences due to per-unit developments – primarily pricing, while volumes were somewhat decent. There were also some cost-heavy line items in conjunction with certain products going into operations.

The essentials segment is more geographically based, and saw declines across the entire world, reflecting the ongoing macro developments. This again had mostly to do with pricing levels, as volumes were good. But due to poor pricing, every segment was down with NA down “the least” at “only” -4.7%.

Brenntag also isn’t seeing the “light at the end of the tunnel” here. Rather, markets are expected to continue to stay competitive here, with Brenntag forecasting around €1.1-€1.2B, which is a cut of about €200M since the last forecast in EBITDA. There is a clear indication, according to both companies and sources in the industry, that prices will remain pressured due to both overcapacity but also a lower overall level of demand. This is added to by less supportive development in terms of volumes for 2H24, i.e. results in terms of volumes are bound to decline. To this comes the uncertain geopolitical situation, which further adds to the company’s near-term woes.

This does not take away from the company’s eventual upside once this recovers. This is a company that over time has proven its resilience and ability to outperform, even if at times results are a bit more volatile and contain downturns.

Brenntag remains a market leader with a product portfolio matched by very few, and it also has proof of delivery for many of its upsides. It has a solid, asset-light business model, implied and confirmed by its ROCE of over 14% and generates hundreds of millions in FCF typically, with €10B since IPO and over €3B of that returned to shareholders. Brenntag has a very solid M&A track record, with over 100 M&A’s since the IPO, growing its footprint and expertise, and between its two specialized divisions manages over 250,000 customers and over €4B worth of annual gross profit.

Its portfolio consists of over 600 facilities/sites and sites in over 72 countries.

While 2023 saw a drop for the company in terms of results, the overall trend for Brenntag is a very solid one. Brenntag has been able to generate ROCE significantly above its level of WACC – which is around 6-9% depending on the interest rate, and it offers a cash flow profile that is almost countercyclical, as evidenced by its performance during COVID-19. Even macro downturns have not made this company unprofitable, and I doubt this is going to change.

The perhaps biggest risk factor is the M&A component of the company. Over the past few years, the company has managed over €5.5B of accretive revenue next to €3.5B spent on over 100 M&A’s – so the results here are good, but that is of course no guarantee for the future. I keep an eye on every large M&A that the company does, especially considering it says it has identified over 400 potential M&A targets for its two main segments alone.

That aside, Brenntag remains a very conservative low-leverage (1.4x) IG-rated chemicals business that suffers from very few of the same risks that we see in other chemical players like BASF (OTCQX:BASFY). That’s why I’ve also been favoring and allocating more to Brenntag as the company has grown cheaper.

The valuation outlook for Brenntag is now as follows.

Valuation for Brenntag – The upside is now there even with conservative estimates and forecasts

I of course remain conservative in my estimates for any company, especially chemical companies. But with sub-40% long-term debt and a 3.23% yield for the native BNR ticker at this time, there are reasons for some upside at least.

Brenntag typically, looking at the 15-year average, trades at 18.25x managing a 9-10% average CAGR in EPS growth on an adjusted basis. As of right now, that valuation is down to 13.8x for the native, which implies not only undervaluation to the conservative 15x P/E but to the typical 17-18x P/E as well.

The second question becomes if there is any underlying reason that is worth discounting the company. The answer here, as I see it, is yes. The company is facing difficulties in forecasting a clear return to growth, so even the estimates of 12-14% growth in 2025-2026 are potentially doubtful here, confirmed by an over 30%+ negative miss ratio in terms of this company’s forecasts. (Source: F.A.S.T graphs paywalled link)

So we have reasons to discount, and we have reasons to expect lower returns on a forward basis than maybe before – but I don’t see the long-term being impacted as much as that.

Even if we discount the company to less than 8% average annualized EPS growth, and if we go down to around 15x P/E, we still get 15-18% annualized from this investment under current forecasts. And if we allow for premium – say 17-18x, that turns into 25-30% per year, and a total Ror until 2026E of around 78%. However, this also would require a triple-digit share price.

I’m more comfortable forecasting in the conservative ranges. I believe that Brenntag, following this latest drop, is most definitely undervalued. The drop is an overreaction, no more than that, based on what’s expected to happen in 2024, and maybe even early 2025E (we’ll have to see how the markets develop).

Because it’s an overreaction, consequently the logical move for me is to consider adding to Brenntag. While I haven’t added more yet, I’m ready at this time to change my rating for Brenntag and move from a “Hold” to a “Buy”, which I am doing in this article.

The relevant ADR for Brenntag I would choose is BNTGF, a 1:1 ADR. My previous PT was €80/share native, which would come to around $90/share for the ADR – which is also my target for that specific ticker.

You have to expect a year or two worth of waiting time for this investment to mature, but overall I view this as a good investment, and my thesis for Brenntag is now as follows.

Thesis

• Brenntag is a world leader in chemical distribution. No other player really 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 its double-digit return potential based on extremely attractive exposures and trends as we move forward. At least, this was the case almost 16 months back. It’s moved up and down since then, and is now back “down”.
• I give Brenntag a conservative PT of €80/share. That’s as high as I currently go based on the growth estimates.
• For now, as of September of 2024, I move my rating to Brenntag to a “Buy” once again. I still have a decent position in the company, but it’s one I will, as the rating suggests, once start to look to expand my position again. I would start selling if we approach a €90-95/share price, depending on what opportunities are available then.

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 expansions/reversions.

The company is no longer cheap here, but it does fulfill all of my other demands. I say therefore that it qualifies for a “Buy” rating.

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