The Croda International (LSE:CRDA) share price is down around 7% after a disappointing trading update. As a result, the stock is down 33% since the start of the year.
I think this is an overreaction, though. To me, it looks as though the market is fixating on some short-term headwinds, creating an opportunity for investors to consider buying.
Profit warnings
The headline news is that sales volumes over the last three months haven’t been strong for Croda. As a result, 2023’s income is going to be around 20% lower than previously anticipated.
Adjusted profit before tax is now set to be between £300m and £320m – significantly lower than the £370m-£400m expected before. And it looks like an even bigger disappointment compared to 2022.
For Croda, £300m-£320m in profits amounts to around £2.14-£2.29 per share. Last year, the company’s earnings per share came in at £4.65.
Right now, the Corda share price is around £44. That puts the stock on a price-to-earnings (P/E) ratio of between 17 and 20, based on this year’s estimates.
With the average P/E ratio for FTSE 100 stocks being around 10, an investor might think that the stock hasn’t really fallen enough to justify the earnings decline. But I think there’s more to it than this.
Supply and demand
Croda’s income decline is the result of weak demand across several of its end markets. The company sells into various sectors, but only its pharmaceutical division showed any resilience.
Elsewhere (industrial, consumer care, and crop protection) customer inventories built up during the pandemic are still at elevated levels. That’s weighing on sales volumes and revenues.
The business has been battling this issue all year, but it’s taking longer than expected for demand to recover. There’s a risk this could take more time, but I see it as a short-term problem.
Inventory levels are high at the moment because of a one-off event – the Covid-19 pandemic. This boosted demand for the company’s products, especially its chemicals used in drug development.
Importantly, Croda is in a decent position to weather a short-term storm, with a strong balance sheet and its debt under control. I expect it to emerge on the other side in a good position.
A cyclical stock
In 2022, Croda generated £4.65 in earnings per share as the pandemic boosted demand for its pharmaceutical chemicals. As a result, the reached a price of £104 per share.
This was clearly the result of a short-term surge in demand though, so buying the stock then would have been unwise. Now, though, the reverse could be true.
At around £2.14, the company’s earnings per share are set to be much lower than they were last year. And the Croda share price has fallen to £44 as a result.
Yet to my mind, this is clearly due to a short-term headwind for demand. I therefore think profits are going to be higher in the future and this is a good time to consider buying the stock.
