Innospec Continues To Hit Its Marks, And Performance Chemicals Is Showing Exciting New Potential

I'm accustomed to quiet excellence from Innospec (NASDAQ:IOSP), a small ($2.7B market cap) specialty chemical company with operations in fuel additives, personal/home care, and oilfield services. Typically not well-covered by the Street, Innospec has generated mid-teens long-term returns for investors and has continued to build the business through a combination of organic reinvestment and selective acquisition. It's been a while since I've written about the company, but it has continued to execute well. Up about 10% since my last update, Innospec has beaten the market over that time, as well as many of its specialty chemical peers.

With management reinvesting more aggressively in growth opportunities within specialty chemicals for personal care and looking to drive improved operating leverage in the oilfield services business, I'm still bullish on the company and I find the valuation more interesting here. If mid-single-digit revenue growth and mid-to-high single-digit FCF growth are credible, these shares could still offer double-digit annualized return potential from here.

 

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Innospec Continues To Hit Its Marks, And Performance Chemicals Is Showing Exciting New Potential

Innospec - Recovery Leverage And M&A Capacity

 

With highway traffic still down meaningfully in the first quarter and oil/gas production activity likewise well off prior norms, it's not exactly business as usual for Innospec (IOSP), but the arrow is definitely pointing up.

As lockdown restrictions ease across the world and economic activity gets back to normal, I expect to see meaningful rebounds in the Fuel Specialties and Oilfield Chemicals businesses of Innospec. Meanwhile, the Performance Chemicals business never saw the same volume pressure, which makes sense given its leverage to personal care products like shampoos and laundry detergent.

Given Innospec's strong balance sheet, I fully expect management's attention to turn toward M&A in 2021, and I believe agriculture and mining may be areas of particular focus. The possibility of such M&A does create some modeling challenges, but with the rebound in the shares since my last update, I believe these shares are priced more as an attractive hold than a materially undervalued opportunity.

 

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Innospec - Recovery Leverage And M&A Capacity

Innospec Leveraging New Growth Opportunities And Driving Margin Leverage

While I liked Innospec (IOSP) back in May, I never got the dip into the $70’s that I was hoping for, as the company has done a very good job of executing on some emerging growth opportunities in Fuel Specialties, as well as its long-term plan within Oilfield Services. Even the execution in Performance has been commendable, as the loss of volume to a significant customer and some adverse mix-shift has been offset by surprisingly resilient gross margins.

My biggest concern for Innospec going into 2020 is the risk that weak U.S. onshore drilling and fracking activity could sap the momentum in the Oilfield business. While Fuel Spec likely won’t see the same sort of volume growth it has in recent quarters, the longer-term opportunity in low-sulfur marine fuel (under IMO 2020) looks appealing. Valuation for this almost-uncovered specialty chemical company isn’t ideal, but management has shown the virtues of its diversified business model and it will likely take some weak quarters to open a window of opportunity.

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Innospec Leveraging New Growth Opportunities And Driving Margin Leverage

Innospec Offers Steady Performance And Occasional Opportunities

Among specialty chemical companies, Innospec (IOSP) is a relatively low-drama player, with a solid management team that generally does a good job of managing its businesses to the realities of their respective end-markets – maximizing margins in slower-growing businesses, but exploiting growth opportunities where they are available. Innospec doesn’t often get all that cheap apart from broader market/sector pullbacks, but those are good times to reconsider these shares.

Innospec has come off a bit from a recent peak and the shares aren’t all that exciting from a DCF-driven value perspective, though an EV/EBITDA approach offers a little more upside. Capital deployment into growth M&A remains a definite possibility, but I’d prefer to try to pick up shares in the $70’s if possible.

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Innospec Offers Steady Performance And Occasional Opportunities

Innospec Seeing A Hiccup In Margins, But The Core Business Looks On Track

Specialty chemical companies have continued to do alright this year, as volumes and pricing have helped partly offset increasing raw material pressures. Innospec (IOSP) has been a bit of a laggard since May, though, with the company’s second quarter report hurting the share price as investors didn’t like the weaker than expected margins in the business. I had thought Innospec looked a little pricey when I last wrote about the company, but I do see some upside here as I expect the company to benefit from some lagging pricing actions. If Innospec can get the Oilfield business in better shape, there could be more meaningful upside.

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Innospec Seeing A Hiccup In Margins, But The Core Business Looks On Track

Innospec Has The Opportunity To Leverage Self-Help And Growth Markets

Small and not widely followed, specialty chemical company Innospec (IOSP) has a pattern of nearly annual sharp pullbacks that give investors another chance to get into what has been a pretty good growth and quality story over the years. There are a lot of moving parts here, and management needs to work on the profitability of the Oilfield segment, but I like management’s track record as well as the growth prospects for a specialty chemical company focused on products that offer important performance enhancements to markets that will pay for them.

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Innospec Has The Opportunity To Leverage Self-Help And Growth Markets

Innospec Offers More Upside On Growth And Margins

The last year or so has been a choppy one for Innospec (IOSP), as volumes and price/mix have been choppy across the business and the company absorbs the lower-margin business it acquired from Huntsman (HUN) at the end of December 2016. As far as peer comparisons go, Innospec is a tricky stock to benchmark given its mix of businesses, but I’d call its performance since October of 2016 “middle of the pack,” with companies like NewMarket (NEU) and Solvay (OTCPK:SOLVY) doing worse and companies like Ecolab (ECL), BASF (OTCQX:BASFY) and Lonza (OTCPK:LZAGY) doing better.

Looking ahead, I believe it will be quite a while before the electric vehicle revolution materially impacts the fuel specialties business, and I think the company has a long growth runway for its performance chemicals business. Its oilfield chemicals business should continue to benefit from improving U.S. onshore activity, while the octane additives business will continue to exist in a regulatory twilight zone.

If Innospec can generate mid-single-digit revenue growth and drive FCF margins back toward 10% on sustained improvements in the performance and oilfield chemical businesses, a fair value in the low-to-mid $70s seems reasonable and can support a long position today.

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Innospec Offers More Upside On Growth And Margins

NewMarket Needs To Find New Markets To Drive Growth

NewMarket Corp. (NYSE:NEU) is an unusual company in many respects. A strong player in additives for lubricants and petroleum-based fuels, it has an enviable track record for EBITDA margins, cash flows, and returns on capital when compared to other specialty chemical companies. The company has been fairly generous about return capital to shareholders, but a lack of stock splits has led to a high absolute share price and somewhat thin trading volume, as well as minimal sell-side coverage. What's more, while NewMarket is good at what it is and generates healthy cash flow, it has taken a different path from many of its specialty chemical peers that have been looking to deploy their cash flow into diversifying acquisitions.

I like how NewMarket operates, and I think the expansion of the company's presence in Asia will improve the company's top line growth prospects. That said, I still don't believe the overall top line growth outlook is all that good, and the share price already seems to anticipate quite a bit of cash flow growth.

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NewMarket Needs To Find New Markets To Drive Growth

Innospec In A Lull, But A Big Deal Can Drive Value

I liked Innospec (NASDAQ:IOSP) as a value play back in April, as I thought the Street was too caught up in the weakness in the Oilfield Services business and overlooking the long-term potential in the core Fuel Specialties and Performance Chemicals businesses, as well as the possibilities for value-creating M&A and an eventual recovery in the oil business. I didn't expect the stock to be this strong, though, with the shares up almost 40% since that last piece.

Innospec was doing pretty well on its own through August as margins were holding up better than analysts expected. The big jump came with the second quarter earnings, though, as the company announced the $200 million acquisition of Huntsman's (NYSE:HUN) European surfactant business. Although this business looks more commoditized than Innospec's Performance Chemicals business, there are opportunities here for cross-selling and margin improvement and this gives Innospec a European foothold that could prove more valuable in the years to come.

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Innospec In A Lull, But A Big Deal Can Drive Value

Seeking Alpha: Innospec Muddling Through Better Than Most

Small specialty chemical company Innospec (NASDAQ:IOSP) continues to operate pretty strongly despite headwinds that would (and have) smacked other companies hard. Back in May of 2015, I thought the valuation was a little iffy and that it would be best to wait for a pullback; the shares did pull back into the low $40s in late summer before an impressive run to almost $60. Then the weight of weakness in the oilfield really hit the stock, sending the shares back down almost where we started from back in May of 2015.

It's probably too much to hope that Innospec sees its oilfield chemicals business return to growth this year, but the business has remained profitable and likely will stay so long as conditions don't worsen (another oil price pullback to old lows). Meanwhile, I think the fuel additives business will continue along while the performance chemical business grows nicely with strong volume growth driven by the personal care segment. With a clean balance sheet, and a stated desire to do more deals, I'm tempted to look past what will be a tough 2016 and pick at these shares now that they once again appear undervalued.

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Innospec Muddling Through Better Than Most

Seeking Alpha: Innospec Continuing To Build A Quality Business From A Small Base

While Innospec's (NASDAQ:IOSP) foray into oilfield chemicals has run smack into price-related activity declines in North America, this small specialty chemical company continues to leverage a strong fuel additives business and a growing value-added personal care performance chemicals business. With the balance sheet flexibility to add more specialty business lines and a reasonable valuation, this company should still be look forward to above-average growth and margin leverage prospects.

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Innospec Continuing To Build A Quality Business From A Small Base

Seeking Alpha: Sluggish European Demand May Be Opening A Window Into Innospec

I've liked specialty chemical company Innospec (NASDAQ:IOSP) as an operating entity for some time, but I've been less excited about the stock given its valuation. The shares are now down more than 20% from my initial write up and down a similar amount since my last write up, though, and that makes the risk-reward balance more interesting. While I do have some concerns that demand in Europe for the company's fuel additives will weaken further, I like the long-term outlook for the company's oilfield chemical and personal care performance chemical operations.

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Sluggish European Demand May Be Opening A Window Into Innospec

Seeking Alpha: Still Waiting For A Better Entry Point On Innospec

When you find a chemicals company that can routinely post double-digit returns on assets and invested capital, it's worth paying attention. Likewise, not many $1 billion companies can get meaningful share in markets when competing against behemoths like the chemical operations of Exxon Mobil (XOM) and Chevron (CVX), or Berkshire Hathaway's (BRK.A) Lubrizol. Now, with Innospec (IOSP) making it clear that growing its oilfield chemicals business is a priority, I'd say the story is getting better.

Valuation still remains an issue. I've liked Innospec as a company for quite some time, but as I observed about six months ago, the valuation was and is fairly demanding. The stock hasn't done much in the interim, and I'm likewise concerned that investors buying today may be facing a wait as the company "grows into" its valuation and as the market expects more moves to build the oilfield operations.

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Still Waiting For A Better Entry Point On Innospec

Seeking Alpha: Innospec Looking To The Next Run

Specialty chemical company Innospec (IOSP) has been quite the stock over recent years. Up almost 40% over the last year, over 60% over the past two years, and over 600% over the last five years, Innospec has done a good job of leveraging its solid share in fuel additives and surfactants used in personal care products. Along the way, Innospec has also uncovered a pretty interesting growth opportunity in drilling/oilfield chemicals that could ultimately increase its addressable revenue opportunities by several times.

The only "but" in the story is the valuation. As strong as the markets have been, this is a familiar lament (particularly from value-oriented investors like me) and certainly not exclusive to Innospec. On one hand, I do recognize that this company is well-positioned to out-grow the average specialty chemicals company and continue to generate good margins and returns on capital. On the other hand, you do have to stretch the growth estimates and/or multiples to generate an attractive price target today.

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Innospec Looking To The Next Run

Investopedia: Innospec Might Be A Name To Watch In Specialty Chemicals

It seems a little strange that a specialty chemicals business with $750 million in annual sales and strong returns on capital would be a virtual unknown, but that's the case for Innospec (Nasdaq:IOSP). Although this is a company with input cost exposure and somewhat volatile free cash flow, investors may want to keep an eye on this name as a potential value in the sector.

Addressing Huge Markets for Specialty Chemicals  
Broadly speaking, the markets for fuel additives and chemicals used in personal care products are huge. While there are many competitors, including major chemical companies like DuPont (NYSE:DD), Dow (NYSE:DOW) and BASF, this is nevertheless a market where offering the right proprietary product can drive premium pricing and reliable business.

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