Hexpol - A 50 bagger

I am currently trying to go through all stocks in the Nordics from A-Z. The approach I have taken is to take a list of all reporting companies from January 1st to March 31st and just pile through it. 


Today I stumbled upon Hexpol, which is quite interesting to study. The reason is that the stock is a ~50 bagger since early 2009 (after 2008 results released). What caused this?

• 3,5x revenue increase
• Almost 2x on margins
• Expansion from 9,7 in 2008 to 17,5 in 2015
• 7x multiple expansion
• P/E rising from around 3 in early 2009 to 22 in 2015

It is a hell of a result and shows the underlying drivers of exceptional stock performance. In order to reach extreme results you need help from all levers, great future business results combined with a fantastic entry valuation. And then you have the hardest part which is to be patient and just stick with it to let compounding do it's magic. 

Let's look into Hexpol's business

HEXPOL is a world-leading polymers group with the main business area called Hexpol compounding (93% of sales). They also have a BA called Hexpol Engineered Products making up 7% of sales

HEXPOL Compounding focuses primarily on three key segments of the polymer market: 

• Rubber compounds 
• Thermoplastic elastomer compounds (TPE) 
• Thermoplastic compounds (TP) 

HEXPOL Compounding have 30 manufacturing units (mostly acquired) in Europe, Asia and NAFTA 

Market - mainly automotive

Automotive industry constitute some 40% of sales and demand is highly linked to car sales. Hexpol provides e.g. these plastic sealing strips for doors and windows. 

They also see growing customer applications in the medical technology, general industrial and oil and gas industry.

Industry in consolidation

• The industry has three main groups:
• Small number of global players 
• Many smaller local/regional players
• Customers with proprietary rubber compounding operations

We have two distinct industry trends driving growth:

• Consolidation of the industry
• Hexpol grows quite a lot by acquiring and integrating smaller players in their operations. They can then generate value by implementing best practices and move production between units production performance. 
• Outsourcing by vertically integrated customers
• Customers with rubber compounding operations have difficulty to keep their internal units competitive with more focused external players. Therefore we have a outsourcing trend increasing the addressable market for Hexagon.  

Operational set-up and strategy

• Decentralized structure but trying to leverage some scale advantages (in global unit)
• R&D - global coordination between units in development of new materials and products. 
• Purchasing
• Price negotiations and strategic supplier choices. However, main input is commodities (e.g. oil based materials) which limits the leverage a large buyer can have.
• Engineering (design of equipment)
• Separate units 
• Responsible for sales, product development and production
• Benchmark and implementation of best practices in between
• Product development to avoid commoditization
• E.g. 80% of products in Europe are based on "unique proprietary formulas"
• Around 5% of employees engaged in product development. Very low percentage of sales though. 
• Objective of being most cost effective company in the industry
• Global scale is an advantage
• Hexagon can deliver the same products with same quality to e.g. a global automotive company which is a competitive advantage relative to prue regional players.

Investment opportunity?

Before I would invest in Hexpol I would like to understand the following:

• Runway for growth
• How large share of the industry sales is either smaller regional players or customers with in-house production
• More detailed knowledge of scale advantage
• Hexpol grows by acquiring smaller players, integrating them and rolling out best practices. 
• On average what is the margin difference between a Hexpol operated unit relative to a independent one? 
• What is the main drivers of this?
• Hexagon has 30 production facilities. 
• Why can not a competitor get better economics by putting up a huge production facility? Need to understand the production economics.
• How can they keep 17,5% operating margin in the automotive industry?
• Main driver here is having a large part of sales in differentiated products. Why will this area not become more standardized resulting in margin pressure?

In summary:

Hexpol is an interesting company and I suspect that they have what Bill Ackman calls platform value. They are in a fragmented industry and could have unique capabilities (expertise and scale) which enable them to improve performance of acquired companies in a way that few others could, resulting in excess returns on M&A. 

With 500 MSEK in net cash we also have a potential to leverage up the balance sheet. Hexpol makes it to the watch list and with their exposure to the highly cyclical automotive industry we can hope for some bad times and an entry point.