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Transcript

Welcome to ICF Capital Pulse. This this episode we're focusing on specialty chemicals industry. Specialty chemicals are driving innovation in chemical production. Consumer demand is driving this. But why should this sometimes forgotten or dare I say unsexy sector be of significant interest? We have Christopher Nicholson here to discuss. How are you, Christopher? I'm very well, Scott. It's always a pleasure to be here with your finance, TV and doing Capital past. We look forward to it. So do I. OK, so let's jump into it. Why should investors be interested in specialty chemicals? Well, as you said, you know, it is kind of an unsexy sector. I mean, you know, it's not NVIDIA, etcetera, etcetera, It's not Bitcoin. So sometimes we feel like it gets a little bit forgotten. But actually we think it's a really, really interesting sector. And because it gets a little bit forgotten, there's loads of value in there. That's our view and really at this point. There's some really interesting developments happening. So you touched on the fact that there really being driven by changes now in consumer demand. So consumers are demanding sustainability within their products. So what's happening is the way the value chain works is that the specialty chemicals companies, they buy raw materials on the downstream and then they sell up their formulations, their innovations and their IP. They sell that up to companies like Unilever who then. Put it in that products and then start telling consumers, yes, we're listening to you, we are changing our product. So you've got a moment of change and innovation. And when that happens, the people actually creating innovations, they tend to be able to improve their margins. And if they're protecting it with IP, then of course they have even more control out of that. And of course when you're innovating, it is difficult to get formulated out. You you can be replaced of course, but you know there's a brand impact sometimes for that. Christopher Should specialty chemicals remain in that unloved bucket? Like what can the can the second ever be popular with investors? I, you know, it's a great question because it sounds like a huge ask because it's complicated. There are many, many sub segments, but I think it can. And the reason I think it can is that I want to give you an example here. So if you think about what you might call the kind of grooming space or the personal care space. So in in face cream products, for example, I think actually in pretty much 95% of those personal care products, there is a chemical. Compound referred to as a surfactant, which has a particular role. So it's about 95% of those compounds contain that. And you can make a surfactant essentially in one of two ways. You can use natural gas as the feedstock or you can use a bioproduct bioethanol as the feedstock. Now at the moment the vast majority of surfactants are using the natural gas product. Now, consumers may not be fully familiar with the feedstocks, but what they are saying to the big retail consumer brands and to the small independents and this is something we'll come on to, which is really interesting. Now answer the small independence. They are saying we want to sustainability, we are interested in ESG and are you tracking the chain? They're not expressing it quite the way I'm saying it. But this is what they're demanding and we know this because the because company, these kind of companies that are filling the shelves. Supermarkets with brands and in and big chain stores and also the new special speciality independent retailers that are coming up in this sector. They are telling the specialty chemical companies, you know, we need a formulation that meets these criteria. So that's driving change. So because it's consumers, because that's retail investors, we think that there is a possibility that it could, you know, potentially become a really sexy sector. I know everybody who sees this will laugh when I say that at the moment. But I I'm going to put my, I'm going to, I don't know, I'll put $10 on it. It will become a sexy sector in the next five years. Alright, so how specialty chemicals enhancing the efficacy and safety of health and hygiene products? So, So what they're really doing is, is the, the mandates that the specialty chemicals companies are getting or that they are bringing to the table is, is, I suppose threefold. They're saying, look, first of all, they are safer for the environment. And, and, and they're looking at what is the, you know, the whole life cycle of the compound. And they're looking at the important factors like how quickly does it break down in the environment? So, you know, once it's been used and it ends up in the waste process system. Or landfill or whatever it is, they are saying, OK, this got to breakdown a lot quicker, it's got to be less toxic, et cetera. So that's one area that they can that they are innovating in. The other area in terms of sustainability as they're saying rather than using cracked products from fossil fuels, which is where most of these chemicals originally came from stocks, we are turning to things like cornstarch, bioethanol, etcetera, which of course they still have an environmental impact when you are farming on mass, but. It is a much more sustainable approach. It's not perfect, but it is a big step forward. OK. Well, can you provide some color on the trends towards biobased ingredients and the development of environmentally friendly or at least more sustainable chemicals? Yeah. So I think the best way to kind of think about this is that if we take, if we sort of just in this kind of format rather than dig into exactly what the chemical changes are, if we just say, look, they're using bio products rather than natural gas and fossil fuel products. And then we look at what's the end result. Well, the end result is this. You've got about just to put this in perspective. A company like Crowder is now producing about 60% of its chemical formulations, which it describes as sustainable and biobased. A company like Iconics, much smaller bit of a startup, not well more than a startup, but you know, just shaking the tree a bit in the in the sector, it's pretty much 100% of its raw materials, sustainable and bio derived. Then when you look at the marketplace itself, the rest of the specialty chemical companies as a general. Group are producing about 20% of their specialty chemicals as bio based raw materials from bio based raw materials. So what this tells us is that there is clearly enormous consumer demand for this. So there is a lot to go for. There's another really interesting thing about the way the chemicals industry, especially chemicals industry works, which is that broadly speaking about 2% of their additives or products are responsible for the volume of what you're consuming. But there are about 5% of the value. So when you then take this and then you look at the. Another interesting thing, and this is a thing investors have to have to really think about and understand about the sector is the contract basis. So everybody is used to a pitch which says this is a service on demand all instead of selling the piece of software or selling the whole item in one go, you get charged every month. So we have repeatable revenues. We can't be substituted out. And you know this is. The goal, the Holy Grail sometimes, especially at IPO Lebanon things, well, especially chemicals doesn't work that way. And it sounds when you first hear it like it's a bad thing, but it's not. It's a great thing. So the way their contracts work is this. They don't have permanent contracts. They essentially have an agreement to supply a certain amount and then when that amount is supplied, there's a new negotiation, new agreement. So that's both on the raw material side, the stuff they buy in and then they make their stuff. Then they sell it on and also the contract. So that same in nature there. So Unilever won't say to Crowder, right, for the next 36 months we want you to deliver 25 kilos or you know, whatever it is per day of this product. That's not how it works. They say here's our order, please deliver, etcetera. It works much more like that. So not shouldn't be thought of as fixed long term contracts should be thought of as very flexible contracts that are short. Why is that great? Because it sounds like a terrible, terrible thing. It's great because raw material costs have a high impact on the pricing and when you got inflation, it affects pricing and production costs. So you're able to go to your raw material suppliers at one end and say, OK, we need to negotiate this or right, that's the new price. So then you go back to your end purchaser and say here's the new price. Given that we are IP based, given that this is an innovative period, you are going to have to pass the cost on or you're going to have to take our cost. So yes, the end. Just the, you know, the end buyer is cost sensitive, but the specialty chemicals companies are actually in quite a strong position with this sustainability Dr. What's happening is that the, the, the company branding and making the product put it on the shelf. They are making claims about their brand to, to the consumer to address consumer demands. So you can imagine if you've got an IP based product in your product to so you can say those things, reformulating it out or switching it out and going back to say. And that gas fossil fuel product, that is quite a thing you've got to think about because you're damaging your brand potentially or you have to reposition the brand. And This is why we like that right in the middle there. And at this period, it's great and you can get, you know the gross margins are rising. We would say 35% is a really, really good gross margin for this, this type of business. Iconics is delivering 35%. I think crowd is possibly closer to 2829, but This is why we like it. Well, that actually leads me into a great question, a big humble asking the question. But what sort of companies might investors consider spending some time on? Well, as it happens, we really like the UK market. We think there are a few things here that that can kind of trigger the imagination. One, we as a as a nation, we are still recognized that being fantastic at innovation and creating IP, et cetera. The specialty chemicals companies, they are really driven by science and R&D, OK. And then they have all this IP as we say, which is very, very valuable. It's a fantastic environment and the UK market. Is definitely undervalued by a couple of turns. So it looks really good. So they're leading innovation, they're undervalued by a couple of turns and we think, you know, that will be closed. There was some kind of reasonable investing horizon. And so to give an example of of two ends of the spectrum where you could go to there about 10 you could look at in the UK that would be worth spending a bit of time on probably. And, and, and if you look at the two ends, you've got ITX right at the small micro cap end, innovative 100% biobased. And then you got Crowder, sorry. And the other thing about TX is currently it's got a limited number of clients. It had a bit of a shock in fact, because it did get reformulated out. So it's changed its strategy now and it's going for a much broader, smaller group of clients, but it's less dependent. So it's, you know, the revenue strategy has changed. Crowder on the other hand has a huge number of products and a huge client base and it's a mid cap. And again, it by any reasonable measure, it looks pretty undervalued at the moment. And there's one of the. Other little thing I wanted to touch on that's changed that I forgot to say earlier Scott, which is that the advance of digital marketing has really changed the way these companies can sell and the extent of their market. So that profitable long tail which was not available to them is now suddenly available and makes sense. So if you are an independent retailer, you know think about the brewing market, you know different market but. Lots and lots of new producers of small volume, small batch beers. It's the same thing is happening in personal care. You are getting these independent companies that are very small. Ordinarily it would not make sense to try and market to them in the normal way with advertising, etcetera. But with digital marketing it makes financial sense to do so than itself stimulates innovation because there's a place for these companies, small companies to go where they've got expert reformulation teams in the, in the specialty chemicals companies. Things like I need my product to do this and I'm going to make it look like this and especially chemicals capitalists come back and say, sure, no problem, here's what you need. That's not increase, but thank you very much for your time. I'm sure the investors are going to love this. Thank you, Scott. I mean, it's always fun, so my pleasure. Everyone else out there, good luck investing.