- Ingevity is a small, niche, specialty chemicals producer with fairly strong fundamentals, but a few issues to consider.
- As the price falls, the valuation becomes much more enticing.
- If issues begin to be offset over the next few quarters, I believe the company is worth further consideration.
Introduction to Ingevity
Ingevity (NYSE:NGVT) is a diversified specialty chemicals company that focuses on innovating sustainable applications for the modern world. Spun-off from WestRock (WRK) a few years ago, NGVT has actually performed better than their former parent. Whether this is due to the environmentally friendly focus or chemical market strength is unknown, and a comparison is not the focus of this article. Instead, I would like to highlight a potential investment in an overlooked sector of the "ESG" market. Ingevity is able to take advantage of the newfound love for sustainable and eco-friendly products, and this will continue the upward trend for the company. While there are a few financial issues to consider, and growth will not be groundbreaking, I find that Ingevity may become worthy of consideration for more risk-averse investors in a short amount of time.
Ingevity has two revenue segments: performance materials to control gasoline vapor emissions and for various purification applications, and performance chemicals such as for use in pavements, various engineered polymers, and a variety of industrial specialties. The wide range of offerings is beneficial in that no one unit has an undue impact on the company, but also limits growth for the same reason. However, I find many of their applications to be fascinating, as they offer significant improvements over traditional chemicals and materials, but with less environmental impact.
According to the company, many of their products are produced from sawdust or wood pulp, and so the company is able to have a renewable feedstock if sourced from producers such as Timber REITs or Forest Operators (direct suppliers include WestRock and Georgia-Pacific). Sales are also diversified by geography, with a good amount coming from APAC and EMEA, although NA remains the majority source. Although, the strong USD may lead to minor to partially significant FOREX risk in the short-term as US interest rates rise.
It will also be important to watch pulp prices, which are hard to track due to the heterogenous industry. Although, prices across the board remain elevated and may impact profitability. Due to the specialty nature of NGVT's products, I assume there is some level of inflation coverage priced into their contracts, but it may be an unknown factor to consider. However, as of the last earnings report, revenues do not seem effected, and in fact, beat expectations by $46 million.
Moving to the financials, we can see a slow, but steady, upward trend in revenues even considering the effects of the pandemic. While initial profitability declined after the spin-off in 2016-17, it returned to form for the past few years. Net margins during high performance periods averaging around 14% are quite high. Net income was affected significantly in 2021 due to penalties awarded due to litigation vs BASF (OTCQX:BASFY) during a patent battle. This litigation is still ongoing so may weigh on the valuation for the next year or so. Perhaps it will make you reconsider investing as well. The short-term weakness will probably be fixed over the next few quarters and may lead to an optimal entry point.
Although, along with middling growth and litigation issues, there is also balance sheet weakness. While FCF has been positive for some time, debt was increased to $1.5 billion in 2019, close to 50% of the market cap at the time. Thankfully, the debt has slowly been reduced, but remains above $1.3 billion as of the last earnings. Meanwhile, cash has always been limited, and is currently less than $300 million. Since growth has not seen much benefit, I find this debt issue to be relatively unproductive so far, and would look to see the company reduce it at a far faster rate. Thankfully, when profitability returns to normal levels, it will not take too long for the debt to be reduced.
The current weakness of the financials and in the market as a whole has led to share price underperformance as well. The share price is currently almost 50% below all-time highs that were met in 2019. Further, the valuation is at a low point, not seen since close to IPO and in the pandemic crash. Although, due to the hit to net income, the P/E ratio remains elevated at 20x. By the next few quarters, I expect the P/E to fall down closer to 10.0x to match the undervaluation of the P/S ratio.
At 1.7x, the company is at quite a discount, and value investors should take advantage of the falling price. However, I would expect certain criteria to be met first before meaningful margin expansion occurs. Another specialty chemicals company I also favor is Element Solutions (ESI), and I share my thoughts here.
One of the first criteria is to end the litigation process, as these factors often hamper a company's share price regardless of the outcome. While I suspect there was limited foul play, even though they lost the lawsuit, it is a point to consider when investing.
Secondly, I believe the company needs a catalyst to drive revenue growth upwards slightly, as recent growth has flattened. The debt raised in 2019 did not seem to impact the top-line, so one wonders how useful the raise was. As the debt falls, investors can be more comfortable with the asset.
Third, I believe the short-term risk due to interest rates, worldwide growth, and general market pessimism all hinder the share price. With no end in sight to the pessimism, I hesitate to recommend adding shares, unless you begin recurring investments to average out a low price.
While I support Ingevity and their work in producing bio-based and sustainable chemicals and materials, there are a few issues that have and will continue affecting the share price. As such, I will not be investing, but recommending you add the company to your watch list. ESG spending is increasing significantly and economical, leading NGVT to have a revenue growth rate that remains positive when looking back five years.
In the future, I believe the company can move back to between 7.5-10% revenue growth per year. Combined with high profitability, I expect the company to have the opportunity to offset the negative factors I discussed above. Improving fundamentals is always an important way to support the share price even as market optimism tanks. Do you believe the company has a high chance of expanding their valuation again?
Let me know in the comments. Thanks for reading.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of ESI either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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