Elementis has “lost direction” says fund manager Gatemore – The Armchair Trader

Activist fund manager Gatemore, which specialises in UK small and mid cap investments, has gone on the warpath, with an open letter critical of the management of chemicals company Elementis [LON:ELM]. This follows a previous private letter to management and conversations with the board.

Gatemore seems most concerned about the weak share price of Elementis. Note however that Elementis stock is up 15% over the past 12 months and over 10% YTD. Gatemore, however, seems to think the company should be doing better.

“We recognise the fundamental strengths of the company and the opportunities for significant improvements if corrective actions are taken now,” Gatemore CEO Liad Meidar said in its letter. “After extensive outside-in due diligence, which involved consultations with industry experts, former executives, investment banks, and Elementis shareholders, we hold a strong conviction that Elementis is a business with a robust asset base, abundant growth opportunities and outstanding potential.”

Gatemore pointed out a number of fundamental strengths of the Elementis business, which include the mission-critical nature of rheology modifiers in the end product formulation, and customer loyalty, with coatings manufacturers seeing significant benefits from maintaining long-term relationships with providers after the product has been formulated. It also highlighted a distinctive competitive advantage through ownership of a hectorite mine in California which also underpins significant asset value in the business.

What’s upsetting the team at Gatemore then?

Gatemore said that many of Elementis’ current problems are self-inflicted and demonstrate a continued failure of judgement of the company’s top leadership team, most notably the CEO. Since the current CEO Paul Waterman came into the office in 2016, Gatemore said Elementis has delivered subpar Total Shareholder Returns as compared to its peers, despite the share price having been supported by three takeover approaches throughout the period.

During its recent Capital Markets Day in November 2023, Elementis management unveiled a $30 million cost-saving program scheduled for 2024 and 2025. This program comprises a $20 million “Fit for Future” organisational restructuring initiative and $10 million of procurement and supply chain efficiencies.

“Given that the current management has been in place for over seven years, it is puzzling why such actions were not implemented sooner,” Gatemore said. “It also raises questions as to whether the transformation could in fact be expedited, with majority of the cost savings realised as early as 2024.”

Gatemore said the market is also sceptical of the Elementis management’s ability to deliver, which is reflected in the street consensus anticipating only a 17.7% EBIT margin by 2026. “This forecast falls considerably short of management’s target, raising concerns about the lack of transparency and detailed disclosure surrounding the plan,” the fund manager added.

Gatemore is pushing for the removal of the CEO but is also critical of the board, pointing out for example that the non-executive directors hold less than 0.05% of total shares outstanding, worth approximately £332,000, while at the same time earning approximately £526,000 in board fees.

“Indeed, the UK Corporate Governance Code discourages companies from incentivising directors with equity, but we believe this is a fundamentally misguided approach and one of the reasons why UK equity markets are so dramatically underperforming and therefore struggling to attract foreign capital or new listings,” Gatemore said.

Is Elementis really doing that badly?

The Armchair Trader ran some independent peer analysis on Elementis using the AI screens at Bridgewise. This rates Elementis a Hold, with Bridgewise saying that Elementis is expected to “significantly outperform the industry benchmark.” Where Elementis lags competitors is in areas like its balance sheet, although cash flow looks good compared to peers. Bridgewise also highlighted a drop in free cash flow as an area of concern.

Elementis also lags peers in its return on equity ratio at 3.46%. This compares with Croda at 7.17% and Johnson Matthey at 7.11%, or Victrex at 12.3%. Sadly the Elementis dividend yield at 1.1% is also significantly underperforming peers.

Ultimately there may be some grounds for concern here: the data presents a deteriorating rather than improving situation on a peers comparison basis, despite the improvement of the share price, which the algorithms usually like.