These days, it can be easy to get caught up in the buzz that inevitably accompanies the latest investment fad. However, the prudent value investor must always be on the lookout for solid companies with a proven track record to complement their riskier plays.
Enter Innophos Holdings Inc. (IPHS, Financial), a leading manufacturer of specialty ingredients, with partnerships in more than 70 countries that span the food, health, nutrition and industrial sectors. The company operates three businesses: Food, Health and Nutrition (55% of sales in 2017), Industrial Specialties (36%) and Other (9%).
Follow the money
As of writing, the stock is trading at $40.14, down almost 26% from its yearly high of $54.14. What has changed since then? Sales have grown steadily over the last year: ($165.9 million in the first quarter, $179.4 million in the second and $183.8 million in the third), demonstrating a clear pattern of growth. Costs have also been rising, however, and long-term liabilities have increased by 68% year over year. As a result, per-share earnings remained stagnant over the course of 2017 (55 cents in the first quarter, 57 cents in the second and 58 cents in the third), which the market has understandably interpreted as a negative sign.
That said, the picture looks brighter when one considers these costs have piled up as a result of an aggressive drive by management to add $450 million in acquisitions by 2022. In 2017, Innophos purchased Novel Ingredients ($125 million) in August and NutraGenesis ($28 million) in November to strengthen its Food, Health and Nutrition arm. Both of these deals are expected to become net positive for earnings within 12 months and are projected to deliver cost synergies of $4 million in 2018.
Management has also embarked on a cost-cutting program, which is estimated to yield $13 million in savings in 2018. Therefore, the run-up in debt should be not be viewed in a vacuum; rather, it should be seen in the context of a long-term plan for the company.
The positives
Innophos Holdings has a highly diversified consumer base, with no single customer accounting for more than 10% of sales in 2017. While diversification should be important to every business, it should be of even greater importance to a company like Innophos, which operates in markets tightly correlated with those for agricultural products.
Changes in weather conditions that affect the price of products such as grains, sugar and livestock will have knock-on effects on customer orders that will vary country by country. As stated earlier, 55% of all 2017 sales came from Food, Health and Nutrition, so the extremely wide range of countries in which Innophos does business insulates the company from shocks that could wipe out a smaller and more specialized competitor.
Revenue from sales to producers of products unrelated to agriculture, such as petrochemicals and detergents, will also go a long way to providing a cushion against shocks.
The dangers
When assessing Innophos’ prospects, we identified two major risks. First, there is the danger that management has overplayed its hand by being overly aggressive in pursuing new acquisitions. Whilst it is difficult to say for sure whether this will end up being the case, the fact both deals are projected to become accretive to earnings within 12 months is encouraging.
The second, and more realistic, issue is the market may take some time to realize the increase in costs will be offset by an increase in sales and revenue from the addition of Novel Ingredients and NutraGenesis, meaning the share price remains stagnant for some time. In that case, more risk-averse investors may want to wait for the next earnings call to see some evidence of a pickup in earnings per share before jumping in.
Verdict
We believe the slide in share price that has occurred over the course of the last year does not reflect the intrinsic value or potential of Innophos. True, earnings have been so-so, but we see this as a temporary issue associated with the mergers and acquisitions-heavy strategy being implemented by management. The holding company’s size, diverse range of products and wide customer base give it the edge required to succeed in the market for specialist ingredients.
Overall, we view Innophos as an attractive opportunity for investors in search of robust growth over the next several years. It may take a while for the market to wake up to Innophos’ potential, but patience should pay off.
Disclosure: I/We own none of the stocks discussed in the article.
(This article was co-authored by Stepan Lavrouk, whose research and insights form the article's thesis. Lavrouk is an investment analyst with Almington Capital.)
