Croda has the right elements to enable it to flourish

Croda International

389¾p +10

Questor says BUY

Good companies as well as bad companies have seen their share price hammered over the last year. Today I want to highlight one of the good ones.

Croda International is a world leader in the manufacture of speciality chemicals. It is likely to see some hit from the parlous state of the global economy, but Questor still regards it as a defensive business. The shares have fallen 46pc from their peak on May 5 2008 and Questor believes that this has created an opportunity to get in ahead of a strong set of full-year numbers.

The group manufactures chemicals for the healthcare businesses, the cosmetic industry and crop care products that are used in herbicides and insecticides. Its other products include lubricants for the oil and gas industry, solutions to help in textile processing and polymers for plastics and packaging, plus many, many more.

It also supplies ingredients for the high-end cosmetics sold by luxury brands such as Chanel and Estée Lauder. "We appeal to two things that will never go away – vanity and ageing," Croda chief executive Mike Humphrey said after its last results statement.

Around 75pc of group earnings come from its consumer care operations, mostly low-ticket defensive items. Its industrial products cover a wide range of sectors, which should provide some earnings protection next year – although total volumes are likely to fall.

The latest full earnings statement covers the six-month period to June 30 2008. Despite the cost inflation in this period, the company managed to post an increase in pre-tax profits of 64.1pc. When the performance of discontinued businesses is stripped out, pre-tax profits actually jumped a stunning 90.3pc. There was a one-off spike in glycerine prices, which flattered the results in the period. The spike provided an additional £4.9m to earnings, constituting just over 9pc of total profits in the period.

The disposal of non-core businesses has also reduced net debt, which stood at £364.7m at the end of September. Disposals in the first half included the sale of Baxenden Chemicals in February 2008 to Chemtura for £13m and its Chicago Oleochemical business was sold to HIG Capital in May 2008 for £45.1m.

The company managed to fully recover the cost of increased raw materials prices in the first half. However, input costs are now likely to move lower, which should help to boost margins. Of course, customers will be demanding that these cost savings are passed on, but Questor expects that the company will not transfer 100pc of the reduction, which should provide a cushion from falling volumes.

The currency markets are also moving in the company's favour – so this should help boost full-year numbers, which are expected to be released in February 2009. So far this year, sales and earnings have been boosted by around 10pc by currency movements.

Collins Stewart has calculated that if exchange rates stayed at their current rate, earning in 2009 could see a 15pc boost. However, Questor expects that the pound may slide further in the next six months – providing an even greater currency-related gain.

The UK contributes less than 10pc to total sales, with around 50pc coming from Europe and 25pc from the Americas.

The company's latest trading update was issued at the start of November – and management oozed confidence. It said global demand for its core products remained robust, with the personal care and crop care sectors showing strong growth.

For the three months ended September 30 2008, sales excluding disposals were £246.7m, up 25.2pc from the corresponding period last year. Pre-tax profit on the same basis was 73.2pc higher at £24.6m due to sales increase, synergies realised from the acquisition of Uniqema, favourable currency translation and a reduced interest charge.

Croda bought Uniqema from ICI in September 2006 and it is still generating synergies from the complimentary businesses.

The company also said that, on a constant currency basis, Croda's average selling price per tonne increased 20.5pc year on year. This reflects not only price increases but also favourable mix from shedding low-quality businesses and the higher sales value of the turnover formerly carried out by third-party distributors.

In the year to December 30 2008, pre-tax profits are expected to jump 61pc to £98.13m and earnings per share are forecast to rise 23pc to 48p. This leaves the shares trading on a current-year forward multiple of just 8 times. This looks far too low.

This is exactly the type of company that Questor is looking for. The board has proved its effectiveness at cost management and the group is well diversified in different markets – from personal care to oil and gas products to crop management. The group generates more than 90pc of its sales abroad, so it will see benefits from a weak pound.

The group is also very cash generative, with free cash flow in the first half of 2008 jumping to £63.9m – 132pc ahead of the first half of 2007.

Questor also likes dividends – and Croda's pay-out looks pretty secure. In 2007, its dividend cover on continuing operations was more than two times. The full-year pay-out for 2008 expected to rise to 18.9p from 15.75p last year, which implies a healthy dividend yield of 4.8pc. Even if there was no increase in the dividend, the shares are still yielding 4pc.

With the company ticking all the right investment boxes, Croda shares are a definite buy.