Croda is defensive, but offers cyclical growth

Croda

561½p +10p

Questor says BUY

This week, speciality chemicals group Croda said that it would close one of its manufacturing sites at Wilton in the North East next year. Although a tragedy for those who may lose their jobs, it seems a sensible move by the company given the position in which it found itself. Croda employs 125 people at the site.

Croda has made the decision because the factory which supplies the raw materials for this site, owned by US group Dow chemicals, is closing down. The Dow site is close to Croda's manufacturing facilities, so half of the site's production will be moved to France plus four other sites around the world. There will be an £18m charge resulting from the closure, which should generate savings of £5m a year.

Dow's plant manufactures ethylene oxide and glycol at the Teesside site and Croda used these feedstocks to produce a number of its speciality chemical products. There is no other manufacturing site for these chemicals anywhere in the UK and transporting these chemicals from Europe to the UK is complex – and therefore expensive.

The investment case for the company still stands. The group manufactures chemicals for the health care sector, the cosmetics industry and herbicides and insecticides. The company also owns a number of patents for its products, which is important. A significant part of its business is consumer care products and therefore defensive, but it is also leveraged to a global recovery through its industrial operations.

In 2008, the company made a pre-tax profit of £98.4m on sales of £956m. Current consensus forecasts for the current year are for pre-tax profits of £99.6m on sales of £942m.

The company posted a strong first-quarter update in April, and it is due to update the market on the second-quarter performance on July 28. In the first three months of the year the group tabled record revenues at its consumer care operations. There was expected weakness in industrial specialities and home care operations. However, it is likely that these full-year forecasts will be met.

Last week, Credit Suisse initiated coverage on the shares with an "outperform" stance and a 700p price target. The broker argued that the market had underestimated the potential for margin improvement in the group's industrial specialities business. The broker's analysis actually showed share-price upside potential of about 60pc if management's targets are met by 2011.

Croda is rated highly by most City analysts. Of those whose stance is monitored by Bloomberg, 10 out of 11 brokerage houses have a buy stance on the shares, with just Citigroup maintaining a hold stance.

The shares, which were first recommended on December 9 at 389¾p, are now up 44pc. The yield, while not outstanding, is well worth having at 3.7pc. The shares are trading on a December 2009 earnings multiple of 11.2 times, falling to 10.2 in 2010, which does not appear too demanding – although it is not cheap.

This rating is a reflection of Croda's defensive nature through consumer care, which accounts for 48pc of sales, and its cyclical upside exposure through its industrial chemicals business. Croda shares remain a buy at this level.

Aveva

693p -14½p

Questor says HOLD

Aveva shares were recommended at 616½p in January. Questor argued that although there was likely to be some softening in its markets, this was already accounted for in the share price.

However, Questor's hopes were dashed and the group issued a profit warning. The stance since then has been hold – and that is maintained after the group's latest trading update.

Despite the warning, the shares are still about 10pc ahead of their initial recommendation price – and the company confirmed yesterday that it was on track to meet full-year expectations. Another strong point in the company's favour is that it still has a strong balance sheet, with net cash of more than £100m.

The company, which designs engineering software for the power, oil and gas and marine industries, said that there had been some softening of its marine operations, but this was expected. Questor noted that this would be the case when the initial buy recommendation was made.

However, the company said that shipyards' existing order books for new vessels had remained relatively solid, supporting recurring revenue from existing licences.

The plant business, where the majority of revenues are driven by oil & gas and power projects, has been more stable.

There was also good news on the company's restructuring, which it said was largely complete. This will allow the group to focus on its lifecycle management product AVEVA NET, which helps management of complex process plants. With capital expenditure budgets likely to be constrained for some time, companies will be seeking to get the best out of existing assets – and this is an opportunity for the group.

The shares are trading on a current-year earnings multiple of 15.3 times, falling to 14.7 next year and the yield is just 1.4pc. Until there is an improvement in the company's underlying markets, the shares are unlikely to be re-rated higher, but the business is solid and the company has already made significant investments in its products, so it can cut back on development expenditure.