They may not be household names, but Univar (UNVR 2.63%) and Balchem Corporation (BCPC 4.34%) distribute many of the chemicals that power everyday life, ensuring cosmetic ingredients and animal nutrition ingredients make it from manufacturing center to market. That niche has served them well, as the duo delivered three-year total returns (stock gains plus dividends) of nearly 40% and 80%, respectively, at the midway point of 2018. That compared favorably with the nearly 40% total return of the S&P 500 in that span.
Unfortunately, things haven't gone so smoothly for the broader flavor and fragrance industry in the second half of 2018, which has forced Mr. Market to reconsider the healthy premiums awarded to shares of chemical distributors. That decision was made a lot easier on Tuesday after the pair released what analysts described as disappointing third-quarter 2018 operating results. Investors are also worried about the implications for Univar's previously announced acquisition of Nexeo Solutions (NASDAQ: NXEO).
As of 2:03 p.m. EST on Tuesday, shares of Univar were down 14.6%, Balchem stock settled to a loss of 7.9%, and Nexeo Solutions shares had declined by 11.1%.
In Balchem Corporation's report, revenue in two segments of the business set records for the third quarter. And there were similar third-quarter records for operating income, adjusted EBITDA, net earnings, and free cash flow. The business also acquired a specialty ingredients manufacturer that will grow its presence in high-value animal nutrition applications. Balchem also reduced its debt -- a big concern for investors in this niche industry -- by nearly $33 million. At the end of September, the company carried a net debt balance of roughly $135 million.
In sum, the business is headed in the right direction overall. But Balchem's quarterly revenue and earnings per share both missed Wall Street estimates. The business delivered sales of $155 million in the third quarter, while analysts expected $163.7 million on average; EPS was $0.59, whereas analysts wanted to see $0.65. It's worth noting that the consensus estimates are based on three individual estimates for revenue and just two for earnings, according to Yahoo! Finance. Therefore, investors may be able to brush off the miss altogether.
Univar wasn't so lucky. The business reported year-over-year growth in revenue, gross profit, and adjusted EBITDA. But continued weakness in Canada (which represents 13% of total sales) sabotaged third-quarter operating performance. Revenue in Canada dropped 8.8% versus last year, while gross profit and adjusted EBITDA declined 13.3% and 23.8%, respectively.
That resulted in quarterly EPS of just $0.35, whereas the average Wall Street estimate (compiled from eight analysts this time) expected $0.42. And it left quarterly revenue just shy of the average expectation for $2.17 billion. The weakness prompted Univar to lower its full-year 2018 financial guidance for adjusted EBITDA and EPS. After previously expecting full-year 2018 EPS in the range of $1.65 to $1.85, the company now expects only $1.60. While that would represent a year-over-year increase of 15%, investors were obviously sour on the update.
In addition to missing expectations and lowering full-year 2018 guidance, Univar's struggles in Canada have investors worrying if there will be any impact on the acquisition of American-based Nexeo Solutions. Shortly after the planned acquisition was announced, even Univar's own management team made comments questioning whether Nexeo's low-value plastics business was a good fit at the larger company. Considering that this segment comprises half of the smaller chemical distributor's total revenue, investors were left scratching their heads at the public comment. Will following through with the acquisition -- and then trying to divest half of it -- add more uncertainty and gobble up too much of management's bandwidth at exactly the wrong time?
Seeing how shares of Univar, Balchem, and Nexeo Solutions trade at hefty premiums relative to their earnings potential, investors shouldn't be too surprised to see market valuations falling on signs of trouble and increasing uncertainty. If global economies begin to cool down after a healthy stretch of growth, then bulk chemical distributors may need to become much more conservative than they already are.
Will they be able to de-leverage (dependent on delivering strong earnings now) in time to wait out a potential down cycle -- or pounce on growth opportunities by acquiring smaller peers in recession-proof specialty markets? Who knows, but that's what investors will be watching in the quarters ahead.