Croda's reduced returns not permanent - broker

Croda International's recent deterioration in returns, marked by a halving of its ROIC ex-goodwill to 11% in 2024 due to acquisitions and rising operating costs, is considered temporary by UBS analysts. They anticipate a recovery in returns and margins, driven by a £100 million cost savings program expected to be fully effective by late 2027 and improved cost control in core operations. UBS projects an upward inflection in returns, sees potential for consensus estimate upgrades (with their 2027/2028 EBIT estimates 7-8% above consensus), and maintains a 'Buy' rating, suggesting a compelling investment case.

Analysis

According to an analysis by UBS, the recent deterioration in Croda International's financial returns is a temporary issue with identifiable and addressable causes. The company's return on invested capital (ROIC), excluding goodwill, has fallen from approximately 24% in 2019 to 11% in 2024. This decline is attributed to the dilutive impact of a re-based returns profile following the 2020 acquisitions of Avanti and Iberchem, coupled with a significant increase in operating costs and capital expenditure. Specifically, operating expenditure reached 27.9% of sales in 2024, compressing the EBIT margin by 570 basis points to 17.2% since 2022, while heavy investment in Pharma capacity has yet to generate commensurate profit growth. UBS projects a recovery, hinging on a £100 million cost savings program set to be fully effective by the end of 2027, which is expected to reverse the margin compression. The bank's outlook is notably more optimistic than the market, with its EBIT estimates for 2027 and 2028 running 7% and 8% ahead of consensus, respectively, suggesting that a reversal of recent earnings downgrades could serve as a primary catalyst for the stock.

Key Decisions for Investors

• Investors with a multi-year horizon may consider the current situation an opportune moment to build or add to a position, predicated on the successful execution of the cost-saving initiatives and the subsequent inflection in margins and returns.
• The primary focus for investors should be monitoring the execution and impact of the £100 million cost savings program, as its progress is the central pillar of the recovery thesis outlined by UBS.
• It is prudent to weigh the near-term headwinds of margin pressure and high capital expenditure against the potential for future earnings upgrades; UBS's bullish estimates suggest upside if management can deliver on its cost-control and pharma-related profit growth objectives by 2027.