Fuchs Petrolub Stock – Hidden Champion for your portfolio?

Owners of Fuchs Petrolub’s stock have had little reason to be pleased in the last two years. And then came the Covid-19 pandemic, where the impact of which on Fuchs Petrolub’s financial results cannot yet be estimated with any certainty. It is not only the global crisis that is causing problems for Fuchs Petrolub, as sales and profits have been falling since 2018, and yet the dividend continues to be increased. Many questions arise: Can a falling profit with a simultaneously rising dividend be sustainable and long-term? And above all: when could the stock price rise again and is the share a buy? You can find out our opinion in this stock analysis.

Fuchs Petrolub stock
Logo
Country	Germany
Industry	Special chemicals
Isin	DE0005790430
Market cap.	5,5 billion USD
Dividend yield	2,8%
Dividend stability	0.91 (max. 1.0)
Earnings stability	0.96 (max. 1.0)

Common share vs. preferred share

Before I go into more detail about the business model, profitability, and dividends, I would like to explain a special feature at Fuchs Petrolub. To invest in the company, you can either buy the preferred share or the ordinary share. The preferred share is more liquid and is represented in the MDAX. It also offers a 1 cent higher dividend as compensation for the fact that ownership of a preferred share does not carry any voting rights. 100 % of the preference shares are free float. Unlike the preferred share, the common share has voting rights, with 55 % of the ordinary shares being held by the Fuchs family. Fuchs Petrolub can therefore still be considered as a family-run company, which is in line with responsible management that prefers the long-term success of the company to short-term actionism.

What is interesting is the difference in performance between the two classes of shares. Over 20 years, the difference is minimal (25.1% for the preferred share and 23.7% for the common share). However, over the last 12 months (as of June 17, 2020) the preferred share (26.1 %) performed significantly better than the common share (17.4 %). When I write in this analysis by Fuchs Petrolub, I mean the preferred share. I chose the preferred share because it is more liquid and generates a slightly higher dividend.

The business model: How Fuchs Petrolub earns money

For over 85 years, Fuchs Petrolub’s main business has been the development, production, and distribution of lubricants. This may not sound particularly exciting at first glance, but over 10,000 products in the range show that not all lubricants are the same. The product portfolio can be divided into the areas automotive (oils, greases), industrial lubricants (oils, metalworking fluids, specialty lubricants), and technical and process-related services. The company operates as a full-range supplier in a very fragmented market.

Fuchs Petrolub generates 54 % of its sales in the Asia-Pacific region, 27 % in North and South America, and 19 % in Europe. The high share of sales in emerging regions of the world is particularly noteworthy, as the markets for lubricants in Europe and North America are already saturated. In the annual report, Fuchs Petrolub lists the demand for lubricants.

Development of lubricant demand (Source: Annual Report 2019) 

You can see from the low growth rates in the above chart that the general market is saturated. To further increase profits in such a difficult market, acquisitions, new product developments, and cost savings are necessary. Fuchs Petrolub works particularly with the first two of these, which I will discuss in detail later.

The revenue by industry is shown in the following diagram.

Revenue by customer sector Fuchs Petrolub stock (Source: Annual Report 2019) 

The chart shows Fuchs Petrolub as a company that is dependent on cyclical industries. Approximately one-third of its turnover is generated in the automotive industry. With the change from the internal combustion engine to alternative forms of propulsion, this sector is in my opinion, particularly at risk. However, Fuchs Petrolub has responded early to the risk of a slump in sales and in one of its annual reports presented three forms of propulsion including the need for various Fuchs Petrolub products.

Comparison of the drive forms (Source: Investor Presentation 2019) 

This figure compares combustion engines (ICE = Internal Combustion Engine), hybrid electric drives (HEV = Hybrid Electric Vehicle), and an electric drive (BEV = Battery Electric Vehicle). Hybrid drives even require more special greases, more lubricants for the auxiliary system, and more coolants and functional fluids. The situation is similar for purely electric drive systems. With its intensive research and development (R&D), Fuchs Petrolub is well equipped for change. This point leads me to an aspect that is particularly important for long-term investors – the moat.

The moat of Fuchs Petrolub

The term moat was coined by star investor Warren Buffet. In 1986, in his famous letter to the shareholders of Berkshire Hathaway, Warren Buffet spoke of a “moat”. He described it as the imaginary protective wall of a company from its competitors’ thanks to a stable business model that cannot simply be copied.

Fuchs Petrolub has seen such a moat through:

• A strong brand that is well known in the industry and that customers trust.
• A management team with a long-term perspective, since more than half of the common stock, are owned by the family.
• Know-how combined with many patents and ongoing R&D (research and development).

Fuchs Petrolub attaches great importance to research and development. More than 10% of the employees work in this area. The aim is to consolidate its technological leadership and to establish and expand new business fields. The lubricant market is served by many oil companies, but Fuchs Petrolub is the number 1 independent lubricant manufacturer.

Ranking top 15 lubricant manufacturers (Source: Annual Report 2019) 

Thanks to this almost unique market position, high spending on R&D (research and development), and close cooperation with customers, Fuchs Petrolub has managed to dig a very interesting moat in its niche. Some lubricants are custom-made for customers, with Fuchs Petrolub holding the patent. Through this close cooperation, the company has gained a pricing power, as in some cases it is not possible to switch to another supplier due to the patents and high development costs of the competition.

It appears that the Fuchs Petrolub stock would be an attractive investment thanks to a solid business model, a deep moat, and the long-term orientation of the management. However, this is not the whole truth and I will now go straight to the less rosy side. I already mentioned the stagnating lubricants market when I presented the business model. This has consequences for profitability and dividends.

Is the success story of the Fuchs Petrolub stock over?

For a long time, Fuchs Petrolub shone with an impressive increase in profit and dividend. Then came the slump in profits in 2019, with profits falling by a hefty 20.8% to the level of 2014, while sales rose by a minimal 0.2%.

Earnings and dividends of Fuchs Petrolub

The company justifies the slump in profits with high investments and acquisitions. The company made three acquisitions in 2019, which should ensure future sales growth. These acquisitions serve in particular to expand the product portfolio in order to be prepared for new trends such as electric mobility. Nevertheless, I would like to note that the impact of the Covid-19 pandemic on the company is difficult to assess. Profit fell by a further 6% in the first quarter of 2020. The company expects a drop of up to 50% in the second quarter and a 30% decline in the first half of the year. It is uncertain whether the second wave of corona threatens us with another economic slowdown. If we are spared the second wave, we can see the profit increases expected by analysts from 2021 onwards.

The operating margin in combination with sales is a meaningful indicator of the extent to which costs change as sales increase.

Revenue and margin of Fuchs Petrolub

At Fuchs Petrolub, it is clearly evident that costs are increasing disproportionately in relation to sales. Sales have risen sharply since the 2009 financial crisis, but the operating margin is falling steadily. A slightly rising operating margin would be ideal. It should be kept in mind how the margin will develop in the future. The company is trying to reduce costs through acquisitions and investments in its own production facilities, but this initially requires higher expenditure. I do not consider the margin problem to be serious, as the company is actively seeking to improve it. Nevertheless, today’s expenditures must actually lead to rising profits in the future. Otherwise, the money would have been better off in the hands of the shareholders.

Is the Fuchs Petrolub dividend secure?

The Fuchs Petrolub dividend has been continuously increased for 18 years and has not been reduced for 27 years. In the Dividenden Turbo you can see that the current dividend yield is 2.7 percent, which is well above the average of the last few years:

Dividend history of Fuchs Petrolub

From the level of the dividend, the Fuchs Petrolub stock seems to be favorably valued. But more about that later. For long-term investors, however, it is not only the current dividend level in historical comparison that is important but whether the dividend can be further increased in the future. To this end, we will first look at the strength of the balance sheet and in particular the level of debt. A dividend financed by new debt would not be an attractive investment.

Debt and amortization power of Fuchs Petrolub

On the positive side, I see the steadily declining debt ratio. Currently, the debt ratio is around 23%. Fuchs Petrolub has an extremely healthy balance sheet and is also financially equipped to invest during the crisis and to continue to be able to afford R&D. The repayment capacity has also always been positive, except for the financial crisis and 2011. This means that the free cash flow is greater than the dividend payment. Free cash flow is an important indicator, as it can hardly be manipulated by accounting tricks. It is calculated by subtracting the operating cash flow and the cash flow from investing activities. Put more simply, free cash flow is the money that is freely available. All expenditures have already been made. Therefore, in my opinion, the payment of the dividend is not in danger. Even if the free cash flow should not cover the dividend once due to the COVID-19 crisis, the company’s coffers would be sufficiently filled to finance another dividend. A critical point I would like to make is that a family-owned company may possibly place long-term business success above the distribution of a dividend.

Valuation – is the Fuchs Petrolub stock favorably valued?

The Fuchs Petrolub stock is valued by analyzing its fair value. Since the calculation of fair value is not an exact science, four different fair values are calculated in parallel in the Dynamic Valuation, each of which is based on a different calculation basis: the reported profit, the adjusted profit, the operating cash flow, and the dividend yield:

Fair value calculation of Fuchs Petrolub

Fuchs Petrolub stock – solid, but not a buy (yet)

The fair values in relation to the latest actual figures are between EUR 32 and EUR 44 and the current price is EUR 35. The effect of COVID-19 on the current fiscal year remains open. According to analysts’ estimates, profit and cash flows for the current fiscal year should decrease. Therefore, the fair values for the current fiscal year 2020 will decrease before profit and cash flows recover and fair values will increase again. Already in the 2021 financial year, the current stock price will align with the fair values. Therefore, despite the decline in the stock price from over EUR 50 to currently EUR 36, the company is not a bargain in my eyes, but it is almost fairly valued. At least if you look at the fair values based on the operating cash flow and the dividend.