This valuation and analysis article is about Aceto Corporation (ACET.) Aceto markets and distributes industrial and pharmaceutical chemicals. The company has three divisions, which include health sciences, chemicals and colorants, and agrochemicals. The health sciences division is involved primarily with pharmaceutical companies in the production of generic drugs. The chemicals and colorants division is involved in developing flavor additives, fragrances, cosmetics, and colored inks. The agrochemical division produces insecticides, herbicides, and fungicides. Description from Morningstar.
Here is a catalog of Aceto’s Human Health products.
Aceto has said that it will not be focusing on the agricultural segment in the future, and in my opinion, ACET should completely eliminate the agricultural segment from its operations. Not only will they not concentrate on it much in the future, it also produces the lowest margins of the three segments. ACET also did not anticipate the amount of competition in this segment, and has thus far been ineffective in trying to compete.
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If you are not going to invest fully in something why do it at all?
As of the most recent 10Q, Health Sciences contributed almost 60% of total revenues, Specialty Chemicals contributed about 34%, and Agricultural contributed about 6%.
I am going to value the company as a whole, talk about the three individual business, give my analysis and then conclusion.
These evaluations were done by me, using my estimates, and are not a recommendation to buy any stock, in any of the companies mentioned. Do your own homework.
All numbers are in millions of US dollars, except per share information, unless otherwise noted. Valuations were done using 2011 10K and second quarter 2012 10Q.
Asset valuation
| Assets: | Book Value: | Reproduction Value: | |||
| Current Assets | |||||
| Cash & Cash Equivalents | 27 | 27 | |||
| Short Term Investments | 2 | 2 | |||
| Accounts Receivable (Net) | 84 | 71.4 | |||
| Inventories | 83 | 60 | |||
| Other Current Assets | 6 | 0 | |||
| Total Current Assets | 202 | 160.4 | |||
| PP&E Net | 12 | 6 | |||
| Goodwill | 34 | 14 | |||
| Intangible Assets | 47 | 20 | |||
| Other Assets | 17 | 8 | |||
| Total Assets | 312 | 208.4 | |||
Total number of shares are 27
Reproduction Value:
- With intangible assets: 208.4/27=$7.72 per share.
- Without intangible assets 188.4/27=$6.98 per share.
EBIT and net cash valuation
Cash and cash equivalents are 27.
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Short term investments are 2.
Total current liabilities are 79.
Cash and cash equivalents + short-term investments – total current liabilities=27+2-79=-50
- -50/27=-$1.85 in net cash per share.
ACET has a trailing twelve month EBIT of 25.
5X, 8X, 11X, and 14X EBIT + cash and cash equivalents + short-term investments:
- 5X25=125+29=154
- 8X25=200+29=229
- 11X25=275+29=304
- 14X25=350+29=379
- 5X=154/27=$5.70 per share.
- 8X=229/27=$8.48 per share.
- 11X=304/27=$11.26 per share.
- 14X=379/27=$14.04 per share.
Revenue and EBIT valuation
Using trailing twelve month numbers.
| Numbers: | ||||
| Revenue: | 455 | |||
| Multiplied By: | ||||
| Average 6 year EBIT %: | 4.42% | |||
| Equals: | ||||
| Estimated EBIT of: | 20.11 | |||
| Multiplied By: | ||||
| Assumed Fair Value Multiple of EBIT: | 9X | |||
| Equals: | ||||
| Estimated Fair Enterprise Value of ACET: | 180.99 | |||
| Plus: | ||||
| Cash, Cash Equivalents, and Short Term Investments: | 29 | |||
| Minus: | ||||
| Total Debt: | 44 | |||
| Equals: | ||||
| Estimated Fair Value of Common Equity: | 165.99 | |||
| Divided By: | ||||
| Number of Shares: | 27 | |||
| Equals: | $6.15 per share | |||
The $6.15 per share is my base estimate of value. My low estimate of value was $3.17 per share and my high estimate was $9.13 per share.
Price to book and tangible book valuation
| Numbers: | ||||
| Book Value: | 169.83 | |||
| Minus: | ||||
| Intangibles: | 47 | |||
| Equals: | ||||
| Tangible Book Value: | 122.83 | |||
| Multiplied By: | ||||
| Industry P/B: | 2.5 | |||
| Equals: | ||||
| Industry Multiple Implied Fair Value: | 307.08 | |||
| Multiplied By: | ||||
| Assumed Multiple as a Percentage of Industry Multiple: | 95% | |||
| Equals: | ||||
| Estimated Fair Value of Common Equity: | 291.73 | |||
| Divided By: | ||||
| Number of Shares: | 27 | |||
| Equals: | $10.80 per share. | |||
The $10.80 per share is my base estimate of value. My low estimate was $8.53 per share and my high estimate was $14.22 per share.
Aceto’s current share price is $9.09 per share. Let’s now take a look at its margins, pros, and cons, to decide which valuation I will be using as my estimate of intrinsic value.
Consolidated Margins:
- Six year gross margin average is 17.1%
- Operating margin, or EBIT margin, has been between 3-6% every year for the last 10 years except 2010 when it was 2.7%.
- ROE has been between 5-10% every year since 2002.
- ROIC has been between 4-14% every year since 2002.
Not great margins by any means, but very stable which is something I like.
Pros:
- Insiders have been acquiring a lot of shares lately, some of which have been exercising of options. Always a good sign to see insiders buying.
- Dividend payer with a low payout ratio, 32% in the trailing twelve months.
- Revenue has been growing: From $229 million in 2002 to $412 million in 2011.
- Very stable margins.
- Many big drugs have come off patent or are going to come off patent in the near future which should help grow revenue further: There are examples of some in this article.
- An aging population needing more pills, should also help continue to grow revenue as well.
Cons:
- ACET has debt as of the most recent 10Q at $44 million, which ACET says will lower its ability to make further acquisitions.
- Does not produce consistent positive free cash flow.
- Does not appear to have any kind of sustainable competitive advantage.
- Although the margins are stable, they are pretty low for a potential long-term buy and hold candidate.
- They are involved in some very fragmented and competitive industries, which could lead to excessive pricing competition and lower margins.
- While the margins being stable is a good thing, they are not growing at this time.
- Most of ACET’s suppliers are in China, which could leave them vulnerable if a recession, political or social crisis occur there.
- Days sales outstanding has risen by 22.6% since 2003.
- Payable period has risen almost 90% since 2003.
- Days inventory has risen by 21% since 2003.
This is how I am understanding the days sales outstanding, payable period, and days inventory all rising:
- Those three are measures of efficiency, and to me it looks like ACET is becoming less efficient.
- ACET is taking longer to confirm payments, it is also taking longer to pay its bills, and it is holding its inventory longer.
All are bad things and could lead to inflated revenue numbers. Please let me know if my conclusions about the DSO, PP, and DI are wrong as I am new at incorporating these metrics into my analysis.
Catalysts
- An aging population that will need more drugs.
- A lot of big drugs have already come off patent or are going to soon.
Conclusion
With all of the above stated I have decided to choose the revenue and EBIT base valuation as my estimate of intrinsic value, $6.15 per share, because of all the risks I see in ACET: I do not see any competitive advantages, it functions in very competitive low margin arenas, etc. My estimate of intrinsic value makes ACET overvalued by almost 30% at this time, as the current share price is $9.07.
At this time I will not be buying any shares in ACET as I think the cons outweigh the pros.
As always your comments, critique, concerns, and thoughts are welcome.