Victrex PLC (LSE:VCT, Financial) is a British specialty chemicals company that is a world leader in high-performance polymer solutions.
The company, which is a FTSE 250 constituent, develops solutions in polyether ether ketone and polyaryletherketone-based polymers, along with selected semi-finished and finished parts. The company was created in 1993 as the result of a management buyout from the U.K. chemicals behemoth ICI Group.
Specialty chemicals is a subsector that appeals to me because companies in this area often make key materials for industries and customers that will be important in the megatrends that are the energy transition and the fourth industrial revolution. In addition, with aging populations in the Western world, medicine should be a long-term growth market too.
Victrex also has an interesting biomaterials unit called Invibio Solutions. Just under half of revenue comes from Europe, the Middle East and Africa, with the rest mainly split between the U.S., Asia-Pacific and China. The company has two operating segments: Industrial at 83% of sales in 2022 and Medical at 17%. The company's revenue was up 11% for 2022 and underlying profit before tax grew 4%.
Sustainable products represent 48% of revenue. Once this number gets above 50%, many sustainability-focused funds, of which there are growing amounts in Europe thanks to the EU’s Sustainable Finance Disclosure Regulations, will suddenly have the mandate to buy the stock. This could be a key catalyst in 2023. The company, which will release first-quarter sales numbers on Feb. 10, has a target of 70% sustainable products making up revenue by 2030.
Further, in its recently released annual report and accounts for 2022, the company noted revenue is above pre-Covid levels, which says to me the sectors it serves, namely automotive, aerospace, energy, industrial, electronics and medical, are back in growth mode.
The company has an excellent Altman Z-Score of 7.86 and a middling Piotroski F-Score of 4 out of 9.
Its GF Score of 69 out of 100, however, is a let down because some growth numbers are undefined, meaning it gets a 0 score there. The score is also affected by a low momentum rank of 4 out of 10, but otherwise, value, profitability and financial strength all score 7s or 8s.
What I like about the company apart from the above statistics is that it is high margin, cash generative and its products are quite innovative and differentiated. Victrex has a market share of over 60% in the niche and very consolidated PEEK polymer market.
It also has a strong research and development pipeline, demonstrated by 5% of revenue having been spent on R&D last year and that 6% of sales were generated from new products. The company defines this as the proportion of group sales generated from “mega-programmes,” which are new differentiated polymers and other pipeline products that were not sold before fiscal year 2014. New product sales is a measure of how successful the company is in driving adoption of its new product pipeline.
Adaption and innovation
In its annual report and accounts for 2022, Victrex identified megatrends it is working to take advantage of in the years ahead. It noted:
"We identify megatrends such as CO2 reduction or health benefits, where our polymers can offer a performance advantage vs metal or incumbent materials. We identify and understand customer needs, targeting industries and applications with opportunities for significant growth and attractive returns."
The company also commented on the different product innovations it is pursuing, saying:
"Our culture is built on continual innovation, with a focus solely on PEEK/PAEK and the high performance materials area, beyond simply manufacturing polymers. We have a high level of technical capability, with investment in Research & Development representing c.5–6% of revenue, and we work with academia and partners to bring new and enhanced products to our customers and our end markets."
Risks
In the company’s December earnings commentary, management was non-committal given the lack of visibility around China, the global economy and industrial end markets. Victrex seemed to be pointing the market toward minimal volume growth for fiscal year 2023. In the annual report, however, the company noted its strong pipeline of medium to long-term growth opportunities, highlighting seven mega-programmes focused on megatrends of “fly lighter” in aerospace, emissions reduction, durability and electrification in auto transport, “thinner, smaller, smarter” in the communications and mobile devices space, the energy transition and aging global population.
While the macroeconomic outlook for 2023 is certainly tougher, I think there is an upside optionality on earnings if Victrex shows faster progress in recovering from the significant challenges posed by cost inflation (the proportion it cannot pass on to customers) that it has seen in past 18 months. However, energy and key raw material price trends are in its favor now. Important raw materials such as benzene and hydrochloric acid have been falling in recent months, as have U.K. natural gas prices.
Valuation
On an enterprise value-to-Ebitda basis, Victrex trades at about 13.9 times, which is roughly in line with its median level of 13.5 over the past 10 years. Its Shiller price-earnings ratio of 16.2 is far below its 10-year median of 24.9.
Further, the GF Value Line suggests the stock is modestly undervalued currently based on historical ratios, past financial performance and analysts' future earnings estimates.
Conclusion
The stock has many things going for it. I will be looking at next month’s first-quarter sales with keen interest to check continued growth.
Victrex is firmly on my watchlist as I try to understand how much of the business is really specialty and differentiated, and how much is commoditized. So while the growth potential is quite clear, the moat seems narrow (high market share in its niche markets) and I am looking for evidence of a wider moat in terms of products, science and technology.
