Solvay SA

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 3/5

Solvay SA is a global chemical company, engaged in the development, manufacturing, and sales of chemicals and plastics. It serves diverse end-markets, including automotive, aerospace, electronics, consumer goods, and healthcare.

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.

Solvay is not a pure play in any specific industry, being diversified across the chemical and plastics sectors.

Business Explanation

Solvay’s revenue is segmented into three primary segments:

  1. Materials: This segment, forming the largest portion of Solvay’s revenues, produces specialty polymers, composites, and advanced materials used in high-growth applications, such as electric vehicles, aircraft, medical devices, and electronics. This is generally the highest-margin business.

  2. Chemicals: This segment includes essential chemicals such as soda ash, peroxides, silica, and fluor. They are used in a variety of end-markets, including consumer goods, energy transition, building, healthcare, and agriculture. This is a more commoditized space.

  3. Solutions: This segment focuses on specialty chemicals, including coatings, adhesives, and specialty surfactants, which are used in applications where product performance and sustainability matter most, such as smart devices, batteries, and healthcare. This segment also includes the new battery materials business.

Solvay is currently undergoing a significant transformation, moving away from commodity chemicals and towards specialty chemicals. Its new strategy emphasizes higher growth businesses, focused on sustainability and specialty products.

Trends in the Industry

The chemical and materials industry is in the midst of major transitions, largely driven by sustainability concerns and technological shifts. Key trends include:

  • Sustainability Focus: Demand for greener, recyclable, and bio-based materials is growing.
  • Technological Advancements: New material innovations are continually changing and improving.
  • Electrification: The electric vehicle market is boosting demand for high-performance polymers and battery materials.

These trends present both opportunities and threats to Solvay, which will be discussed below.

Competitive Landscape

Solvay operates in a competitive industry, facing multiple rivals across various business segments. These competitors include:

  • Specialty Materials: DuPont, BASF, Toray, SABIC
  • Commodity Chemicals: FMC, Tronox, Olin
  • Specialty Chemicals: Evonik, Clariant, LANXESS

Many of these competitors are larger in scale than Solvay, and some are even more specialized in specific value chains. What makes the company different? Solvay tries to balance the production of essential chemicals, specialty polymers, and solutions. The management is trying to move it out of the highly competitive commodity chemical space and into the specialty chemical space where it has a more meaningful technological edge and is able to create defensible moats.

Financials

The latest earnings call was held on 08-09-2024 with all the latest results and commentary for Q1 2024.

  • Revenue: Net sales reached €3.2 billion in Q1 2024, a decrease of 8.4% compared with the same quarter last year, mostly driven by a decline in volumes and prices. Volumes declined by 7.6% and prices by 1.2%.
  • EBITDA: Underlying EBITDA fell by 18.9% to €575 million. The adjusted EBITDA margin decreased 2.3pp to 18.0%.
  • Profitability: Net profit attributable to shareholders came in at €136 million. The Q1 underlying net profit decreased 25% to €227m compared with Q1 2023.
  • Free Cash Flow: Free cash flow from the operations came in at €17 million in Q1 2024.
  • Net Debt: Net debt remained stable at around €4.4 billion.

Several important facts to highlight in these results:

  • The chemical industry as a whole is having a rough time, due to destocking (customers are using their inventories) and decreased pricing. Solvay’s problems are, for the most part, not idiosyncratic but general in the market and for it’s peers.

  • EBITDA margin is still good, but has decreased year over year, which shows that they need to push up volumes or prices to keep making profits, which has not been easy.

  • While most of the results are down, some areas performed better. The Automotive segment had a strong quarter with strong volumes from batteries and electric vehicles. This reflects the demand in the sectors they want to prioritize.

  • They have been consistently investing in capex to transform themselves and grow the specialty chemicals segments.

  • They have been doing heavy acquisitions in the past years, which they are still working on integrating, which costs them some profits in the short run, although in the long-term it might give them growth.

  • They have continued to repurchase shares in Q1 2024, and are committed to further repurchases.

  • They have focused on deleveraging, but high debt levels still remain.

Moat

I am assigning Solvay a moat rating of 3 out of 5. They have made significant improvements and advancements, but their transformation is not complete and their new strategy is not yet proven. The different sources of their moat are:

  1. Intellectual property: Solvay spends heavily on research and development, which gives them a lot of patents for their specialty products. These patents, for example in the battery material space, are valuable and take time to copy. That provides a technological edge to some of the businesses.

  2. Customer lock-in (switching costs): Solvay tends to embed its materials in its client processes, so it is hard for them to replace these materials. For example, in the electronics industry, changing materials can be a long and painful process, involving recertification of the electronics.

  3. Economic moat (economies of scale or scope): While they do not have meaningful economies of scale in manufacturing products, their high investments in capex has created better and more efficient processes, which may create some cost advantages relative to their peers. And by having a wide variety of value chains they also have some scope in their production.

  • However, despite some technological advantages, customer stickiness, and improved operations, the company’s moat can be easily penetrated by larger and more specialized peers. The chemical industry is so big that any of those companies can invest in R&D and processes and quickly replicate parts of Solvay’s business. Also, many of the segments they are in are highly cyclical, which brings a large risk to their earnings.

Risks

  1. Global Economic Slowdown: Since most of their end markets are cyclical, macroeconomic slowdowns can bring down their volumes and sales. Their recent sales show that they are vulnerable to that risk.

  2. Competition: Because many competitors are larger and more specialized than them, those companies can more easily make them lose their market share. This is especially true in the commodity business.

  3. Failure in Transformation : Solvay is currently transforming itself, and there is a risk that their strategy will not pay off and that the results from their new investments might not materialize. There is a risk that their investment in newer technologies may not lead to a return as fast as the management envisions, and their more traditional businesses may experience more headwinds.

  4. Debt Levels: The company has significant levels of debt, which is a risk especially if interest rates rise. There is a chance this high debt is not sustainable if they continue to experience economic downturns.

  5. Sustainability Regulations: Since sustainability is a major trend, increased regulations from governments can influence their product and production choices and could incur some expenses. While regulations could be opportunities to further their specialty products, they could also be impediments on some of their existing operations.

  6. Customer Concentration: While Solvay has many end-markets, most of its value is derived from the industrial sectors. So, any major downturn in the industrial sector, might cause disproportionate damage to their business.

Business Resilience

Despite the many challenges described above, their business has shown great resilience over time, due to its diversified operations and technological expertise. They also have been implementing better cost and capital control measures. As the company transforms and becomes more specialized, we may see a much more stable performance in the next decade. But for now, we have to treat its past financial performance in a highly cyclical and fluctuating world. The management seems very confident that their investments will pay off and that there is not much risk going forward.

Understandability

I assign a 4 out of 5 in understandability. Their business and strategy is not difficult to grasp. It mostly involves a chemical company with 3 segments that provide a variety of products to other companies. It becomes slightly more complicated in understanding the dynamics of the industry, the product pricing, and how they are creating a moat in this highly competitive sector. But in all, the business is fairly easy to understand.

Balance Sheet Health

The company’s balance sheet is at 3/5. While their short-term liabilities are well covered with the current assets, their debt levels are still quite high. It is unlikely that their large debt is sustainable unless they manage to increase their earnings soon. Their ability to repay their debts is still questionable, so this lowers their overall balance sheet health score.

In summary, the current rating of Solvay is a 3/5 moat, 4/5 understandable, and 3/5 balance sheet health.