Jamie Ross, Fund Manager of Henderson EuroTrust, explains Dutch chemicals and ingredients company DSM’s inclusion in the portfolio.
When considering an investment for the Henderson EuroTrust portfolio, we tend not to focus on market noise or any technical factors; the main thing is trying to establish whether what we are looking at is a good company or not. This is a key part of the research process.
Most good companies tend to have many features in common but there are various characteristics to analyse that will be unique. Detailed analysis of the 50 or 60 companies we have on our radar (a portfolio of around 40 positions and a watch list of 10-20 names) we try to ascertain whether a business is a good business and if so, whether now is the right time to be invested or not.
What does the company do?
Dutch company DSM was founded in 1902 as a coal mining company – the name comes from the English translation ‘Dutch State Mines’. The company has changed dramatically since the early 20th century (the last coal mines closed in the 1970s) and over the last 20 years or so, the business has been transitioning again, this time away from chemicals and materials towards food ingredients.
As we stand today, around a quarter of earnings comes from DSM’s remaining materials activities and around three-quarters from their Ingredients portfolio. Within their Materials business, DSM produces and sells sustainable thermoplastics, industrial resins and coatings and a strong fibre called Dyneema. Through its Ingredients division, it sells vitamins, ingredients and solutions for use in human and animal nutrition. In the company’s own words, DSM is focused on “creating science-based solutions in health, nutrition and sustainable living”.
Does this company generate strong return on invested capital (ROIC)?
At the moment, DSM’s ROIC is in the low-double digit percentage range according to our estimates. This is an improvement from recent years and is well above the company’s cost of capital, but is materially lower than the ROIC generated by a number of our well-established ‘Compounders’ within the portfolio. In fact, we see DSM as an ‘Improver’, a business capable of improving its ROIC profile over a number of years.
There are several things that should help to drive this improvement in returns. First, there should be some natural operational leverage from volume growth (costs should grow more slowly than revenues). Second, we see the movement of the company away from the Materials business and towards the Ingredients business as something that should result in higher margins and lower capital intensity. Third, we back the current management team to improve the efficiency of the business over the medium term.
What are the risks to the business and to this ROIC profile?
Inevitably, by having some exposure to materials, which tend to have industrial end markets, there is some cyclicality to the business and if there is an economic slowdown, that could delay the improvements being made. Another risk would be that the company felt compelled to make a large and expensive acquisition to speed up its transition towards Ingredients; we rate management very highly and see this as a low-probability risk. Finally, within the Ingredients portfolio, DSM has some exposure to vitamins – prices that are notoriously volatile – so vitamin pricing is therefore also a risk to the return profile of the company.
Is there scope for growth?
The Ingredients business has significant scope for structural growth over the medium-to-long term. End markets (animal and human nutrition) will see demographically driven growth and ingredients are an increasingly important component of nutrition products. You can also make the case that large ingredients companies with global reach will gain share from smaller local competitors. DSM looks very well placed. We see earnings growth as likely to be faster than revenue growth due to margin expansion.
We have a long-standing position in DSM and it has contributed strongly to performance. We remain positive on the company’s prospects and can see how the business has a good chance of rerating towards that of its Ingredients peer group (DSM currently trades at around 11 x EV/EBITDA; Ingredients at more than 15 times EV/EBITDA).
EV (enterprise value) is the total value of a company’s assets, considering debt and equity.
EBITDA (earnings before interest, taxes, depreciation and amortisation) gives a general idea of how much cash a company is generating.
EV/EBITDA is a formula that divides the enterprise value by EBITDA to give an overall rating. For example, an EV of £100 million divided by £25 million EBITDA gives a rating of 4.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
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