Shares in Croda International (LSE:CRDA) rose 4% last month. That compares favourably with a 2% gain for the FTSE 100.
In its earnings report for the first six months of 2023, the company reported significant declines in sales and profits. So why did the share price keep going up?
Weak earnings
Croda is a speciality chemicals business. It sells its products into three main markets – Consumer Care, Industrial Specialties, and Life Sciences.
All three were negatively affected by excess inventories at customers weighing on demand. As a result, revenues came in 22% lower than last year and earnings per share were down 84%.
Despite this, the share price moved higher for one simple reason. The company had already forecast the decline and this was built in to investor expectations.
At the start of June, management stated that higher inventory levels were likely to weigh on revenues and profits. The stock fell 15% on the news.
As a result, the earnings report didn’t surprise anybody. And it went some way towards reassuring investors that management is on top of the situation.
A cyclical company
Croda’s recent earnings don’t give much indication of what future profitability will look like. Both 2022 and 2023 are likely to be heavily influenced by unusual circumstances.
In 2022, earnings per share were £4.65. But this was artificially boosted by unprecedented demand from Covid-19 vaccine manufacturers that’s unlikely to continue indefinitely.
This year, earnings are set to be much lower – around £1.90. Unusually high inventories are creating a temporary headwind.
The real question for investors is whether earnings are likely to normalise closer to 2022 levels or to 2023 levels. At today’s prices, the stock looks cheap if it’s the former and expensive if it’s the latter.
Outlook
Analysts are expecting earnings to come in at £2.30 in 2024 and £2.49 in 2025. This puts them somewhere between the figures for the last couple of years.
Today’s share price implies a price-to-earnings (P/E) multiple of 26 for 2024 and 24 for 2025. Neither of these obviously puts the stock in bargain territory, so it will need further growth to justify its price.
The company is looking to its pharmaceuticals division for this. By 2030, it’s aiming for £1bn in revenues from those operations as it expands to supply new manufacturers.
If that comes off, the stock might well look like a bargain. But it looks to me as though it’s already priced with the expectation of future growth.
A stock to buy?
Ultimately, I see Croda as one of the best businesses in the FTSE 100. Its strong balance sheet, high returns on invested capital, and sensible management catch my attention.
The company aims to benefit from an expanding sector and it might be able to do this. But it’s unclear to me whether the current share price is too ambitious in terms of future growth expectations.
Pharmaceuticals is a complicated industry. But as it’s a supplier, understanding Croda’s business might be more straightforward than assessing different drug manufacturers.
For now, though, I’m keeping the stock on my watchlist. If the price falls again – as it did back in June – I’ll be looking to make my move.
