Elementis [LON:ELM] the London-based, FTSE250 listed, specialty chemical company has had a rocky year.
The company opened the day (21st November) at 122.86p and has returned 0.4% year-to-date and 16.9% over one-year. The company’s shares have ranged between 96.6p and 131.8p over a 52-week period. The company has a market capitalization of GBP731.6m
However, over the past few months one of Elementis’ significant institutional investors, US fund manager, Franklin Templeton Investment [NYSE:BEN], through its investment management subsidiary, Franklin Mutual Advisers has publicly called (through an open letter) for Elementis’ management to sell the business.
Franklin Templeton owns just shy of 10% of Elementis and has been an investor in the chemicals firm since December 2020. In the September-dated letter, Franklin said: “…we were [initially] impressed with Elementis’ healthy market position in its personal care and coatings businesses. The company’s strong gross margins confirmed to us that its products reside at the premium end of performance additives. As value investors, we were also attracted to a stock that had declined more than 50% since 2016, an inexpensive valuation relative to history and peers, the potential for upside in earnings from a cyclical recovery in the company’s end markets and publicly stated commitment to operational improvement.”
However, over the past three years Franklin became less impressed with Elementis. The fund manager said that in the last few years: “…the company’s capital allocation decisions have contributed to an extremely disappointing degradation in the share price. Specifically, [Elementis] spent USD860m to acquire SummitReheis and Mondo Minerals in 2017 and 2018 […and…] since 2016, the stock price has declined by more than 50% and the company’s current market value is less than the amount spent to acquire these two companies. This is a shocking amount of shareholder value destruction.”
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Cash on the table
The fund manager continued its admonition, noting that Elementis received a takeover offer of 130p in December 2020 from Minerals Technologies [NYSE: MTX] which was followed by a 160p offer three months later from Innospec [NASDAQ:IOSP], both which were rejected out-of-hand by management. Franklin Templeton said in its opinion Elementis did not have the scale to grow, needed a larger strategic partner, and its own efforts to grow organically had been a disaster, had little confidence in the current management and recommend that Elementis put itself up for sale as soon as possible and encourage a pile-on by other shareholders.
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In response, Elementis said it had engaged with Franklin Templeton, but rejected the fund manager’s assertions, and the Innospec and Minerals Technologies offers significantly undervalued the business. Management, in a response published on the RNS platform in September said an immediate sale wasn’t in the best interests of shareholders and while agreeing with Franklin Templeton’s conclusion that it had “attractive assets, [a] healthy market position and strong gross margins” said that the share price and performance were being affected by cyclical themes and was expecting a recovery as the general economic background improved.
Management reiterated its conviction that it was moving towards a medium-term goal of 17% adjusted operating margins with lower volatility, which in the medium-to-long-term would create sustainable shareholder value.
But what can shareholders in Elementis expect? Franklin Templeton itself said that the current share price was at the lower end of fair value, giving a bit of room to appreciate. However, Elementis is not correct in the assertion that the whole Specialty Chemicals sub-sector has performed poorly due to cyclical conditions.
Admittedly using a more general index – the FTSE350 Sector and comparing it to the FTSE All Share return over three years and one year, according to FTSE Russell the three-year return of the FTSE350 Chemicals Sector was 80%, while the three-year return of the FTSE All Share index was 47%, with the Chemicals Sector (albeit the ‘All’ Chemicals sector, not just the Speciality Chemicals sub-sector) outperforming the All Share by thirty-three percentage points. Over one year the race was a bit closer, with the FTSE350 Chemicals Sector returning 28.75% against 17.6% for the All Share. Hence Franklin Templeton does have a point.
Nevertheless, Elementis was right in its assertion that it has been tough out there for Speciality Chemicals manufacturers with a slew of profit warnings from sub-sector constituent at the beginning of the year, given that the manufacturers had hit a ceiling for passing on inflationary price increases to customers, and their clients destocking and using up inventory that was built up during the Coronavirus lockdown. EPS for European Speciality Chemicals companies was down across the board in the second half of the year, so arguably Franklin Templeton is not taking into consideration the performance of the European Speciality Chemicals sector as a whole (in North America Speciality Chemicals has been a little healthier), and Elementis’ management have just cause to reject the goading from their biggest shareholder.
If management gets it way, shareholders might have to wait a bit to start seeing money flowing their way. The company suspended dividends in response to the Coronavirus pandemic in 2020, and although whispers of dividends returning to the menu this year – especially prior to the sale of the company’s Chromium division to Yildirim Group for of USD170m on operational grounds – management hammered a nail in that particular board, saying that at the present time it wasn’t prudent to resume dividend payouts, at least for this year. Instead, the company prudently deployed capital to reduce its net debt, which had been a drag on valuation.
Revenues were up, but so were losses as the halfway point of the year. Those losses were exacerbated by a one-off impairment charge of USD103m in its Talc division. But its drive into Asia and its focus on the higher margin Coatings and Personal Care markets bode well for the future.
Hold on, but Elementis a debatable Buy
The stock still seems cheap, and given an uptick in the global economy, you wouldn’t bet against Elementis hitting that 160p mark under its own steam. However, shareholder dissent isn’t going away, Franklin Templeton was joined in calls for a sale by institutional investors, Schroders Asset Management and Odyssean Capital. How long can management hold out?
It’s hard to say which way this will run, but experience shows that the investors will probably have their way, in which case another UK business, one with a 180-year heritage, might disappear as a standalone entity. If you have shares, its worth holding onto them to see how the game might play out, although it would be a brave choice to dive in now.