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Brenntag BNR
April 27, 2015 - 11:59pm EST by
Astor
2015 2016
Price: 55.57 EPS 2.90 3.35
Shares Out. (in M): 155 P/E 19.2 16.6
Market Cap (in $M): 8,586 P/FCF 20.0 17.2
Net Debt (in $M): 1,472 EBIT 723 823
TEV (in $M): 10,058 TEV/EBIT 13.9 12.2

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  • High Barriers to Entry, Moat
  • Fragmented market
  • Distributor
  • Outsider-type CEO
  • secular tailwinds
  • Capital Allocation
  • Chemicals
 

Description

TEV: E10.1bln (Net Debt E1.5bln)
3-month Avg Daily Volume: 615k shares/day (E34mm)
Investment Horizon: 12-24 months
 
 
I. RECOMMENDATION
A. SUMMARY
Brenntag AG (BNR.GR) is a leading services franchise that benefits from both high barriers to entry and long term secular demand tailwinds.  BNR.GR focuses on serving small businesses that require delivery of less-than-truckload quantities of chemicals; this is a >$400bln market segment that large chemical OE’s have failed to adequately serve as third-party distributor market share has grown from ~15% in the mid-90’s  to >30% today. As the largest third-party chemicals distributor worldwide (though with only ~2% share of the overall market), BNR.GR benefits from both economies of scale and scope versus competitors, resulting in a repeat-customer retention rate of >90%. The BNR.GR business model is highly resilient and characterized by relatively stable above-trend organic growth rates, pass-through of commodity chemical and transportation costs, and strong levels of free cash flow generation given that the business is not very capital intensive. Additionally, BNR.GR is led by a very experienced management team with an exceptionally strong capital allocation track record, and core to their strategy is a disciplined pursuit of accretive m&a opportunities as they aim to continue to be a consolidator of their highly fragmented industry. Despite the strong run in price over the last several months, I believe the shares continue to trade below their long term intrinsic value. Under a reasonable longer term scenario that includes the impact of continued execution of accretive m&a, I derive an NPV of E77 per BNR.GR share, about 37% above the April 27 last sale price, providing a 27% margin of safety.
 
B. RISK / REWARD
BASE CASE:
Currently, I derive a ~E77/share intrinsic value for BNR.GR under two separate methodologies –my base case dcf valuation, and ~12x 2017 EV / (EBITDA – Maintenance Capex) – both methodologies I believe would be appropriate for deriving a longer term value of the business.
 
The main tenets of my base case are:
  • Organic growth of ~5% per annum. In simple terms, organic growth for this business tends to grow at a rate equal to the change in industrial production plus 2%-4% (1%-2% for pricing/mix and 1%-2% for volume growth driven by market share gains). To demonstrate the resiliency of the business model and BNR.GR’s pricing power, organic profit per working day only declined only ~4% in ’09, though industrial output collapsed globally. Given: a) improving European fundamentals b) the structural shift to third-party chemicals distribution, and c) BNR.GR’s competitive advantages as the largest global player in the industry, I believe my medium term organic growth assumption is reasonable.
  • Moderate margin expansion in Europe. European conversion rates (EBITDA / Gross Profit) are >800bps below those of North America. BNR.GR has restructured the European operations to more closely resemble the efficient hub-and-spoke model of NA.  With that, we will continue to see modest margin expansion in Europe (though conversion rates will probably never equal those of NA).
  • And, I believe a great deal of upside value (that is not appreciated by the market) lies in BNR.GR’s ability to grow inorganically. My base case assumes that BNR.GR is able to execute ~E200-E250mm of bolt on m&a deals per annum (and that they are done in-line with historical deal multiples) – this is essentially their targeted m&a transaction level. Frankly, given the fragmented nature of the industry and the significant levels of free cash BNR.GR is generating, management has plenty of runway for m&a.
  • Excess cash builds on BNR.GR’s balance sheet – this is probably conservative to a fault.
  • And, for my dcf analysis, I assume a 7% WACC, and a terminal fcf yield of 6%. Below, a matrix that depicts BNR.GR's NPV under various organic / inorganic growth scenarios.
 BNR GR - NPV per Share 
     Ann. Growth in Organic Rev. ('15-'19) 
         76.5 0.0% 2.0% 4.0% 6.0% 8.0%
 Acquired Gross Profit per annum*  € 0 € 56 € 59 € 63 € 67 € 71
€ 25 € 58 € 62 € 66 € 70 € 74
€ 50 € 61 € 65 € 69 € 73 € 78
€ 75 € 64 € 68 € 72 € 77 € 81
€ 100 € 67 € 71 € 76 € 80 € 85
€ 125 € 70 € 74 € 79 € 83 € 88
 * M&A - assumed at 7% EBITDA margin, and purchase price of 8x EBITDA 
             
 BNR GR - NPV per Share 
     Ann. Growth in Organic Rev. ('15-'19) 
            -   0.0% 2.0% 4.0% 6.0% 8.0%
 Acquired Gross Profit per annum*  € 0 (0%) 6% 13% 20% 27%
€ 25 5% 12% 19% 26% 33%
€ 50 10% 17% 24% 32% 39%
€ 75 15% 22% 30% 38% 45%
€ 100 20% 28% 36% 44% 52%
€ 125 25% 33% 41% 50% 58%
 
RISK:
Given the defensive nature of the business, along with the low level of capital intensity, I believe that permanent impairment to shareholder
capital is fairly limited in just about any scenario. As I see it, the main risks for BNR.GR are:
  • Chemical manufacturers change their attitude about serving small businesses. Based on my conversations with several major chemical makers, I believe the industry not only accepts third-party chemical distributors but actually embraces them as they serve a market niche the large OEM’s can not reach efficiently. As the largest third party distributor, BNR.GR benefits asymmetrically, and major chemical makers actually help BNR.GR identify m&a targets.
  • A sharp and prolonged cyclical downturn. Though I believe BNR.GR’s business would hold up very well (again), my earnings and  cash flow estimates could prove too high.
  • Straying from their current proven capital allocation strategy. BNR.GR has demonstrated over time to be a disciplined acquirer of modest sized chemicals distribution businesses. While I have no indication that they will deviate from their communicated strategy, any change would cause me to change my very positive opinion of the management team.
  • Inability to source m&a deals.  BNR.GR completed ~E140mm in m&a last year, below their targeted range.
  • Approximately 30% of NA sales are to oil/gas customers - so far demand has held up decently, however.
  • Operational risk given that BNR.GR handles hazardous materials. 
  • F/X – most notably, ~45% of profits are in USD. Given the gyrations in currency markets, I believe currency exposure remains a risk for this business. 
  • European interest rates rise (as it would impact my dcf assumptions).
 
II. COMPANY SUMMARY
A. BUSINESS
BNR.GR is the world’s largest independent distributor of chemicals. The company connects chemical manufacturers with small sized businesses throughout North America (45% of EBITDA), Europe (46%), South America (6%), and Asia (6%). In essence, BNR.GR buys chemicals in bulk from hundreds of manufacturers, repackages into smaller sizes (and in some cases mixes chemicals together) and then distributes to ~170,000 of mom & pop sized customers.
 
BNR.GR’s typical customer is a small business with about E7mm of revenues. It buys roughly E2,000 worth of chemicals from BNR.GR every week, or about E100K per year. Given its small size, BNR.GR’s typical customer can’t afford to hire dedicated procurement personnel with expertise in chemical markets and consequently suffer from limited visibility into spot price trends and sourcing options. This unique combination of a small dollar ticket, high operational importance, opaque pricing, ease of one-stop shopping, and the customers disdain for purchasing bulk quantities allows BNR.GR to charge a decent fee for its services. To demonstrate, breaking down an average weekly customer invoice of E2,000 - about E1,600 is for the chemicals, E250 is for packaging and transportation, and E150 is the fee BNR.GR reaps.  The key here is that the customer has little pricing power around the spread that BNR.GR takes (the cost of distribution plus the E150 profit for BNR.GR) - the customer is a small business that is not keen on accessing the chemical spot market in a major way, managing inventory, mixing and delivery, etc., for a piece of his businesses that makes up a small fraction of his revenues but is operationally critical. Moreover, BNR.GR takes virtually no commodity price risk and passes along swings in chemical prices to protect the amount of absolute gross profit dollars it earns.
 
BNR.GR is led by a very experienced and proven management team. Most notably, CEO Steve Holland has been in the chemicals distribution business for 30 years. Holland joined the company in 2007 after he sold his own business, Albion Chemicals, to BNR.GR in 2006.  Furthermore, the current management team has proven to be exceptionally strong at capital allocation, and has performed more than 40 acquisitions for >E800mm since 2007. The company’s m&a philosophy is very simple; they look to acquire chemicals distribution businesses where they believe they can earn a >14% pre-tax IRR (and most of the time the IRR is well in excess of that mark). With ample balance sheet debt capacity (net debt to EBITDA of ~2x vs. a target range of 2.5x-3.0x) and significant free cash flow generation, BNR.GR is primed to continue consolidating this highly fragmented industry. In summary, I’m very happy to give my capital to this disciplined management team given the abundant opportunities in front of them.
 
B. COST STRUCTURE
BNR.GR’s cost structure is highly flexible given that the vast majority of their operating costs (~80%) are essentially passed-through to the customer; basically, COGS is a pass-through item that BNR.GR takes very little risk on. The true costs of operating their business lie in SG&A, and are comprised mainly of labor, energy, and maintenance costs. As the company guides (and I believe makes analytical sense), it’s best to view the margin of their core business as EBITDA / Gross Profit, which they call their conversion rate. In this respect, conversion rates run in the mid-30% range currently, and should continue to expand moderately.
 
C. CAPITAL INTENSITY
One of the most attractive features of the BNR.GR business model is its low relative level of capital intensity. Maintenance capex typically runs just ~E50-60 per annum (vs. total D&A of ~E120-130mm). Working capital tends to grow more or less in line with sales, as the company does not speculate on inventory purchases and usually keeps just 4-5 weeks of chemical inventory in stock. 
 
D. BARRIERS TO ENTRY
Overall, this is a very sound business in my opinion, with pronounced barriers to entry.
  • Economies of scale and scope. It’s virtually impossible to replicate BNR.GR’s global scale from scratch. Scale provides major advantages in terms of route density, purchasing power, customer relationships, wide product selection etc. And, as BNR.GR gains customers and increases their market share, their scale advantage will continue to increase.
  • Permitting. It’s difficult and takes a long time to get the requisite government permits to operate a chemicals distribution facility (especially handling the hazardous materials BNR.GR does handle). BNR.GR has told me that it could take 2-3 years (if not more) to get the necessary permitting to build a new chemicals distribution operation in the developed world.
  • Customer relationships, as evidenced by a very strong (~90%) repeat customer retention rate.
 
III. INDUSTRY SUMMARY
A. COMPETITIVE STRUCTURE
Putting some ballpark figures around the market BNR.GR operates in:
  • ~$1.3-$1.4trln – The total chemical market that is relevant to distribution demand.
  • Roughly 30% of this market (or ~$400bln) is derived from small customers (€100k demand per annum or less). This is BNR.GR’s target market, of which it holds <2% share.
  • About 30% of that market (~$120-$130bln) is distributed by third party distributors like BNR.GR.
  • BNR.GR holds ~7% market share among 3rd party distributors. The market is very fragmented with the top 20 third-party distributors accounting for less than 25% of third-party market share.
 
The key here is that 3rd party chemical distributors benefit from structural growth tailwinds – their market share has grown from ~15% in the mid-90’s to around 30% of the market today. This share will continue to move upwards as key trends in the chemicals industry – consolidation among manufacturers and SG&A restructuring initiatives by OE’s aimed at achieving higher sales per employee metrics –translateinto less of an appetite for the likes of DOW, BAS.GR, etc. to maintain a large sales force to serve small customers who want less than full truckload quantities. As the largest 3rd party provider, BNR.GR will benefit more than its peers given its scale, geographic reach, and supplier/customer relationships. Needless to say, the market opportunity for BNR.GR remains huge.
 
BNR’GR’s most notable competitor is Univar, which is currently owned by Clayton Dubilier. Univar holds ~5%-6% global third-party market share, though is the dominant player in NA, with 20% market share vs. BNR.GR with 10%. Other competitors are much smaller in nature and more specifically geared towards serving a specific geography. So, with a lack of publicly traded comps, BNR.GR is oftentimes compared to other businesses built around distribution models – BNZL.LN, DKSH.SW, FAST, and GWW to name several.
 
B. CUSTOMERS / SUPPLIERS
BNR.GR has about >170,000 unique customers, the vast majority of which are small businesses. Furthermore, the company has no material exposure to any individual customer, and their top 10 customers account for ~4% of sales.
 
As for suppliers, BNR.GR sources chemicals from hundreds of OEM’s, with their top 10 suppliers accounting for ~27% of total sales. In all, BNR.GR supplies more than 10,000 products to customers. In most instances, BNR.GR and their suppliers act in a partnership-like manner (not competitors) as the OEM can not (or does not want to) serve a small customer who wants less-than-bulk quantities of chemicals. Indeed, to demonstrate the partnership-like relationships, BNR.GR will supply proprietary data to many oftheir chemical suppliers, while the suppliers help BNR.GR to identify m&a targets.
 
C. NEW OPPORTUNITIES
There are several avenues of growth:
  • M&A – bolt-on acquisitions have been core to BNR.GR’s strategy. Given strong fcf generation and the fact that the chemicals distribution industry remains highly fragmented, BNR.GR will continue to pursue accretive m&a transactions within this space.  Chiefly, BNR.GR currently wants to expand inorganically in both North America and Asia.
  • New services such as mixing chemicals together based on customer specifications.
  • European Margins – should increase moderately over time as operational restructuring initiatives begin bearing fruit.
 
IV. VARIANT PERCEPTION
There are several components to my variant perception:
  • BNR.GR is not a very cyclical business. Given both structural and secular trends in chemical distribution, and the fact that BNR.GR continues to gain market share, the business will continue to grow at very healthy rates throughout the economic cycle.
  • There is huge opportunity for BNR.GR to grow inorganically and roll-up their fragmented industry. Management has been very disciplined in terms of m&a and the prices it pays for assets – In simple terms, management buys small chemicals distributors for 6x-8x EBITDA and takes about 1x EBITDA out in cost synergies. I fully I expect this disciplined approach to continue going forward.  Consensus estimates do not include any benefit from m&a - these events will continue to lead to modest upgrades to estimates as deals are completed.
  • Despite the strong performance of the shares over the last several month, BNR.GR continues to trade below its intrinsic value.
  
V. SUMMARY FINANCIALS
 
  12/31/11 12/31/12 12/31/13 12/31/14 12/31/15 12/31/16 12/31/17
Summary              
Gross Profit 1,768 1,921 1,946 2,028 2,277 2,485 2,704
   Change 8.1% 8.7% 1.3% 4.2% 12.3% 9.2% 8.8%
   Margin 20.4% 20.2% 19.9% 20.2% 20.0% 20.0% 20.0%
               
EBITDA 657 716 715 727 863 968 1,077
   Margin 7.6% 7.5% 7.3% 7.3% 7.6% 7.8% 8.0%
   Conversion Rate 37.2% 37.3% 36.7% 35.8% 37.8% 38.8% 39.6%
               
EBIT 544 591 575 592 723 823 927
   Margin 6.3% 6.2% 5.9% 5.9% 6.4% 6.6% 6.9%
               
EPS € 1.81 € 2.22 € 2.23 € 2.25 € 2.90 € 3.35 € 3.83
               
Free Cash Flow* 280 324 385 380 430 499 573
   per share € 1.81 € 2.10 € 2.49 € 2.46 € 2.78 € 3.23 € 3.71
               
Net Debt       1,402 1,330 1,214 1,049
   Net Debt to EBITDA       1.9x 1.5x 1.3x 1.0x
               
Multiples              
   EV / EBITDA       13.8x 11.6x 10.4x 9.3x
   EV / (EBITDA - Maint Capex)       14.9x 12.4x 11.0x 9.8x
   EV / EBIT       17.0x 13.9x 12.2x 10.9x
   P / E       24.7x 19.2x 16.6x 14.5x
   FCF Yield       4.4% 5.0% 5.8% 6.7%
   Div Yield       1.6% 1.8% 2.0% 2.3%
               
Free cash flow is defined as net income + D&A - working cap build - capex    

 

(And, a hat tip to golince who posted this idea in 2011, as that report was my first intro to the name).

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Earnings reports (Q1'15 report on 5/6)
  • M&A - as deals are announced consensus earnings estimates will nudge upwards
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