It's getting harder and harder to find good value stocks in the market, even if you have a relatively optimistic outlook on economic growth in 2021 and beyond. That said, if you are willing to consider some of the unfashionable names, you can still find some bargains. In this spirit, let's take a look at chemical distributor Univar Solutions (UNVR +0.00%). It might not be a stock on everybody's lips, but it is a good value that could offer significant returns for investors given the right conditions. Here's why.
Introducing Univar Solutions
The company is a leading player in the highly fragmented marketplace of chemicals distribution. The other two big names are Germany's Brenntag (BNTG.F 4.50%) and another distributor from the Netherlands, IMCD. However, these three together account for less than 10% of the global market. Univar is the leading player in North America and generates 63% of its sales from the U.S. and a further 13% from Canada, while the Europe, Middle East, and Africa (EMEA) region contributes around 19% of revenue.
Image source: Getty Images.
The company's end markets are pretty diverse -- its top 10 customers represent less than 10% of its sales -- but given the heavy industrial focus, it's clear that Univar's revenue growth is tied to overarching conditions in the industrial economy in the Western world.
|
Category |
Share of Total Revenue in 2019 |
Industries Responsible for 5% or More of Total Revenue in 2019 |
|---|---|---|
|
Consumer solutions |
25% |
Pharmaceuticals and finished products: 6% |
|
General industrial |
29% |
Chemical manufacturing: 10% |
|
Industrial solutions |
23% |
Coatings and adhesives :17% |
|
Services and other markets |
11% |
N/A |
|
Refining and chemical processing |
12% |
Energy and power generation: 6% |
Data source: Univar Solutions presentations.
There's no doubt its revenue will come from spending in the industrial sector in general. Indeed, a look at revenue trends for Univar and Brenntag shows how closely tied they are to the industrial economy and overall economic growth. For example, the decline in U.S. industrial production in 2015-2017 leads into a dip in Univar and Brenntag revenue only to lead into a recovery in 2017.
Data by YCharts.
All told, Univar is not a stock for those worried about economic growth in the next few years, but it is a great option for value investors with an optimistic outlook on growth in the industrial economy.
Margin expansion
Univar's revenue is expected to improve in line with industrial production in 2021. The company has an obvious opportunity to expand market share. However, the case for Univar isn't just based on the idea of revenue growth. Instead, the key focus is on margin expansion and valuation.
First, chemicals distribution is a low-margin business, and Univar's earnings before interest, taxes, depreciation, and amortization (EBITDA) margin over the last decade has averaged just 6.6%.
However, having a low margin means that a small increase will translate into a dramatic rise in profits. In this context, Univar's plan to boost EBITDA margin from 7.6% in 2019 to 9% by 2022 really is a game changer. For example, EBITDA was $704 million in 2019. However, an EBITDA margin of 9% would have resulted in EBITDA of $836 million, representing an 18% improvement on the actual total.
Management plans to streamline the organization, reduce costs, sell nonstrategic assets, and invest in digital technologies in order to expand margins. According to executives on the last earnings call, further progress toward the 9% level is expected in 2021, and based on the numbers at Brenntag, it's likely that Univar can get there.
As you can see below, Brenntag actually generates higher EBITDA margin in North America than its home EMEA market. Given that Univar gets 76% of its sales from North America, it appears that the potential for EBITDA margin to increase to an overall figure of 9% is feasible.
| Brenntag |
Share of Total Revenue |
EBITDA Margin |
|---|---|---|
|
Brenntag EMEA |
40.9% |
7.8% |
|
Brenntag North America |
37.3% |
9.9% |
Data source: Brenntag annual report.
Favorable valuation
Univar operates an asset-light business model, which means it tends to do a good job of converting its earnings into free cash flow (FCF). Indeed, based on its price-to-FCF multiple, the stock is very good value.
Image source: Getty Images.
For example, management expects adjusted EBITDA of $629 million to $634 million in 2020, as well as revenue growth and margin expansion in 2021. Moreover, the company aims to convert 40% of EBITDA in 2021 to FCF.
Based on the worst-case scenario figures ($629 million in EBITDA in 2020, no revenue growth, and no margin expansion in 2021), Univar will generate around $252 million in FCF. Given its current market cap of $3.48 billion, Univar trades for less than 14 times 2021 FCF.
A stock to buy
Univar is not a sexy stock, but who cares? The valuation is very attractive and the earnings/FCF growth opportunity looks tangible and within reach. If you are positive on prospects for the global economy and continued progress on Univar expanding its profit margin, then the stock is a very good value in an increasingly expensive market.
