NewMarket Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

NewMarket Corporation (NEU), a specialty chemical company, formulates, develops, manufactures, and sells petroleum additives, primarily lubricants and fuel additives, worldwide.

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.

Business Overview

NewMarket Corporation operates in a fairly niche market, providing additives that enhance the performance of petroleum products. This business is characterized by several key aspects:

  • Product Specialization: NEU doesn’t sell general chemicals or commodities. Instead, it focuses on specialty additives designed for specific industrial and automotive applications. These additives are critical components in fuels and lubricants, improving their efficiency, performance, and durability.
  • Global Presence: The company operates across the world, including significant presence in North America, Latin America, Asia Pacific, and EMEA (Europe, Middle East, and Africa), enabling it to cater to a global market, with production and distribution capabilities in various regions.
  • Customer Base: NEU’s customers typically involve large multinational oil and petroleum companies, as well as lubricant and additive distributors. This implies a B2B model with a large-scale purchasing, making these customers relatively “sticky” and increasing the company’s negotiating leverage.
  • Industry Dynamics: The industry is characterized by several factors. Firstly, a heavy reliance on R&D and technological innovation is crucial for differentiation. Secondly, close customer relationships and long-term contracts are very common. Finally, there is increasing environmental regulation pushing companies to develop products with lower emissions and greater efficiency.

Financial Analysis

Let’s break down NewMarket’s financial picture:

  • Revenue Distribution: The company’s latest results (third quarter of 2024) show a relatively consistent split in geographical revenue distribution, with North America and Europe contributing to more than half. However, the company is seeing increasing growth from Latin America as well.
  • Profit Margins: NEU’s profit margins are very solid. For example, the gross margin in the third quarter of 2024 was 38.5%, showing the ability of the company to effectively generate good profits. A good gross profit, along with prudent expense management, leads to a pretty strong operating profit. Notably, however, in recent earnings calls, there is a discussion of the pressures they have been facing due to rising raw material costs and operational expenses.
  • A key part of evaluating a chemicals business is to understand the ability to pass on costs. If the company can do that, it will have stronger financials.
  • Debt and Financing: The company is relatively stable in its capital structure, with 4.9x net debt to EBITA, after significant debt paydown.
  • The credit profile of the company is well-regarded as it is rated Baa1. This allows it to borrow at lower interest rates, further enhancing its flexibility. The company also had a $400 million of debt reduction in 2021, through some additional assets sales in which some gains where booked. The company is focused on continuing to paydown debt over time, which increases the financial health of the business.
  • Cash Flows: Operating cash flows have been strong, and management has reiterated their commitment to use these to drive shareholder value. Free cash flow has fluctuated but is largely dependent on the capital expenditure done for the business.
  • Strong cash generation also allows the company to focus on organic growth, innovation, and other capital allocation opportunities.

Competitive Landscape and Moat Analysis

NewMarket operates in a fairly specialized industry and has a decent but not wide moat:

  • Intangible Assets: NEU possesses strong intangible assets in its brands, patents, and long-term client relationships. This helps create a barrier to entry, making it more difficult for competitors to win over its customers.
  • However, while this creates some moat, it isn’t particularly that strong as many companies have proprietary formulas/technologies. It still requires time and high costs for a new company to catch up to the existing market players.
  • Switching Costs: There are fairly high switching costs for NEU’s customers, because they need very dependable and proven performance, quality, and reliability from their suppliers of additives. The switching costs are increased by the time investment to build trust.
  • Scale and Cost Advantage: While not the largest in the industry, NEU is still a fairly large company. It is able to benefit from manufacturing and distribution economies of scale. They also produce in regions across the world, cutting down on transport costs, which adds a bit to their scale advantage.
  • Regulatory Approval: Although not a core part of the company’s moat, NEU is a player in a regulated sector that creates an added layer of complexity for new entrants.
  • Overall Moat Rating: 3 / 5 While it does have many aspects of a moat, it is difficult to pin-point a single, overwhelmingly high barrier to entry. Its value proposition is a compilation of several factors that are not too hard for competitors to replicate over a longer period of time.

Risks to Moat and Resilience

Despite its competitive advantages, NEU faces several risks:

  • Technological Disruption: Changes in the automotive industry, such as electric vehicles, and newer engine technology could reduce the need for traditional additives. This is a major risk for long-term earnings. However, they are also pivoting towards developing products for the renewable energy industry.
  • Cyclicality of the Industry: As a supplier to fuel and oil industries, it can be extremely sensitive to the cyclicality of those markets. Economic downturns and the oil price crashes of 2008 and 2020 have shown how profits in this industry can be affected easily.
  • Raw Material Prices: The business relies heavily on raw materials whose prices can fluctuate rapidly, leading to an increase in the overall expense and a dip in the overall net income. They do not have any price-hedging power either because of contracts and customer relationship, causing them to be dependent on market prices.
  • Loss of Key Customers: Since their customer base comprises a few very large players, the loss of one or more of their key customer can severely impact the revenue in the short run.
  • Increased Competition: Competitors in the space can create better formulas or product offerings, making it difficult for the company to retain its customers.
  • Regulatory Changes: Ever-increasing environment-focused and other regulations might prove a challenge for the business model and the type of product they are selling.

Despite the risks, the company has a lot of experience in the field and has been quick to adapt to challenges in the past. The long-term experience that the company possess makes the likelihood of quick, fatal mistakes low. The company’s resilience comes from its diversified customer base, strong balance sheet, a large, well-established network of facilities and a proven ability to generate consistent cash-flows.

Understandability and Ratings

Based on our analysis:

  • Understandability: 3 / 5 The business model is moderately complex, requiring a basic understanding of the chemical industry. A novice would struggle with some of its technical aspects, especially when it comes to understanding its supply-chain and the end use of products.
  • Balance Sheet Health: 4 / 5 The company has a healthy balance sheet with good levels of liquidity and manageable levels of debt. They have focused on improving their debt repayment, and have also done a decent job in keeping capital expenditure in check. The company’s assets are also largely intangible, which can often pose a problem when assets are sold off for cash but are very useful for long-term value retention.