H.B. Fuller Company

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

H.B. Fuller is a global manufacturer and marketer of adhesives, sealants, and other specialty chemical products, serving diverse markets with a variety of industrial, consumer, and specialty applications.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

H.B. Fuller (FUL) has a moat score of 3 out of 5. The core of the business resides in the proprietary formulations and application expertise that have built strong relationships with customers and created high switching costs in many instances. Here’s the rationale:

  • Intangible Assets The company possesses a diverse range of proprietary formulas and application expertise that act as intangible assets, making their products difficult for competitors to directly replicate. This gives them a pricing advantage in certain applications. Their brand presence in specific industries and regions, coupled with their long history in the business, also adds to this advantage. However, this isn’t a universal moat, as some of their products, especially in commoditized adhesive markets are less differentiated and therefore lack pricing power.
  • Switching Costs: Once customers integrate H.B. Fuller’s adhesives into their production process, the cost of switching to another supplier can be significant, especially in specialty applications. This is due to the need for new equipment, re-training, and qualification procedures, leading to high lock-in from the customers. The more customized the product, the stickier the customer relationship. However, customers always seek alternatives and can be very sensitive to pricing when there are good substitutes, such as in the commoditized markets.

  • Cost Advantages H.B. Fuller leverages its large distribution network and its scale of operations to create cost efficiencies in procurement and manufacturing. They can reduce costs by leveraging their existing relationships, distribution, and capabilities. However, many of their raw material costs, such as energy and petrochemicals, are subject to volatile pricing. Although management stated several times, that in its own long term, pricing strategy and raw materials are fully hedged and controlled.

    The rating of a 3 reflects a moderately durable moat. The company has several strong competitive advantages that offer pricing power, but it does face competition in some markets and is dependent on inputs that are not always predictable.

Risks to the Moat and Business Resilience * Raw Material Price Volatility: The company’s margins are sensitive to the cost of raw materials, especially energy, and petrochemicals, which can be volatile. While they have strategies to mitigate these price swings, they can impact profitability. * Competition: The adhesives industry is highly competitive, with numerous players including multinational and regional companies. A few smaller companies have been able to produce better products at a lower price as they are more flexible. This competition can limit their pricing power. * Technological Disruption: There is always the risk of technological disruption and the invention of a new substance that could have better performance, which would make the current formulations obsolete. * Customer Concentration: Although H.B. Fuller caters to many companies, if a few of their major clients decide to switch suppliers (due to an alternative or low pricing alternative), it could significantly impact their revenues.

Business Description H.B. Fuller operates through three main segments:

  • Hygiene, Health, and Consumable Adhesives:
    • This segment manufactures adhesives used in disposable hygiene products, packaging, paper converting, and related applications, like label lamination and tapes.
    • These applications typically require strong bonding, high speed, and reliability.
    • This segment serves consumer-oriented markets.

Revenue for this segment in the last quarter increased by 5.5% with pricing actions, volume growth and margin expansion all contributing. Their focus is on organic sales growth and margin expansion through a continued pricing discipline, product innovation, and strong operational excellence. They also saw continued demand for premium packaging products, which helped improve margins.

  • Engineering Adhesives:
    • This segment caters to more demanding applications in electronics, aerospace, automotive, and infrastructure.
    • This segment focuses more on proprietary and performance-based adhesives.
    • In the past they expanded significantly within the transportation sector.

Revenues in this segment increased by 9% in the latest quarter. Management has focused its efforts to better address the high growth markets in electric vehicles and in general electronics and aerospace and has had significant success in those sectors, especially with new product introductions.

  • Construction Adhesives:
    • Produces a variety of adhesives, sealants, and other products used in residential and commercial construction.
    • This segment is most sensitive to the housing market trends.
    • These products often provide insulation and protection in building applications.

This segment grew by 23.5% in revenue, with increased volumes and positive pricing strategies. Management expects that demand will be stable, and a positive pricing outlook will exist.

Margins: H.B. Fuller is currently focused on improving margins and controlling costs. However, their margins are influenced greatly by the price of their raw materials. Their recent acquisitions also added to their operational expenses, which impacted the margin. * EBITDA margins are in the low to mid-teens range, which is good, but not the most attractive. The focus is on improving profitability by increasing prices on products that have strong brand loyalty and switching costs.

In the last earnings calls, management emphasized multiple times, that their focus is on margin improvement and reducing expenses. They are implementing a pricing strategy where they are getting a premium for differentiated products and are also optimizing material usage.

Competitive Landscape: The adhesives market is highly competitive, featuring large global corporations as well as smaller regional suppliers. Key competitors include: * Henkel * Sika AG * 3M * Avery Dennison

H.B. Fuller competes on a combination of price, quality, innovation, and customer service. They aim to be at the forefront of adhesive technology, which may make their products more desirable.

What Makes H.B. Fuller Different:

  • Global Presence: FUL has a strong global presence, allowing it to operate in diverse markets and have a more consistent revenue base, insulated from economic changes in a particular geography.
  • Innovation and R&D: The company invests in R&D to develop new and specialized products that offer a technological advantage over the competition.
  • Proprietary Formulations It uses proprietary formulas and technical expertise to provide custom-made adhesives, creating value for its clients.
  • Customer Relationships: The company focuses on building strong relationships with its customers and offers tailored solutions, rather than just commoditized products.
  • Strong Focus on Sustainability: There is a focus on product innovations and operational excellence to reduce their carbon footprint. This has been received positively by consumers and regulatory agencies.

Financials * Revenue: For the most recent quarter ended June 2nd, 2024, total revenues reached $817 million, a 7% increase compared to the same period last year. The growth is attributed to growth in all the main segments and positive pricing strategies. * Profitability Adjusted net income for the quarter was $70.5 million, a 43% increase YOY with the biggest driver being improved margins. Adjusted operating margins was 12%, up almost 4% YoY, showing efficiency in the company. However, higher interest rates have reduced net income and this effect was more pronounced in this quarter. * Liquidity and Leverage: As of September 2, 2023, they had cash and cash equivalents of $350.1 million, compared to $199.9 million on November 26, 2022. They also have total debt of approximately 1.76 billion, with a net debt of about $1.4 billion. This might be a concern, and should be carefully monitored, but this seems to be under control, for now, as they have also reduced their debt, mainly due to improved cash flows. * Debt Structure: H.B. Fuller utilizes a mix of fixed and floating-rate debt. Most of their debt is long-term, with a significant maturity in 2031. This ensures stability and predictability in their finances and their ability to sustain operations in a high-interest environment.

Management has been focusing on deleveraging the balance sheet. After a few quarters of paying down debt, they intend to start allocating capital to other uses, such as repurchases. H.B. Fuller’s target leverage ratio is 2.0-2.5 times net debt-to-EBITDA. * Capital allocation: The primary focus for the management is to continue reducing debt levels as well as grow the business organically by using their existing capabilities. They intend to spend money on acquisitions only after achieving their debt-reduction targets and where there is a high amount of synergy. They will also increase their investments into more sustainable materials.

Understandability: 3 / 5 H.B. Fuller’s business is complex due to the large number of its products, different applications and industries that it is present in. Their geographic diversification further adds to this complexity, however, they do present the financials by business segments and therefore, it’s manageable. Their competitive landscape and strategy also have a few nuances. All this makes it more difficult to truly comprehend this business, compared to a more easily understood business.

Balance Sheet Health: 4 / 5 H.B. Fuller’s balance sheet is relatively healthy, but could improve. The company has a good cash balance of $350 million (up compared to the previous year), and their debt has been reduced, which gives them some flexibility. Although their leverage is in the slightly higher range, they intend to continue paying it down. As they improve their operations and continue to increase their margins, their financials are set to get even better.

The main areas of concern for H.B. Fuller remain its ability to control the prices of their raw material inputs, as it is subject to volatility, and competition from other suppliers. Management has been clear about addressing these concerns, but investors should continue to be cautious. Overall, H.B. Fuller is a solid business with a respectable moat, but management execution will be critical for them to succeed.