Balchem Stock: Acquisitions And Cost Pressures Draw Attention (NASDAQ:BCPC)

Elevator Pitch

Balchem Corporation’s (NASDAQ:NASDAQ:BCPC) stock is rated as a Hold based on my analysis.

My prior August 2, 2021 article for BCPC focused on the company’s record-breaking Q2 2021 financial results. This latest update for Balchem touches on its recent acquisitions and the inflationary cost environment, things that have drawn the attention of investors.

I continue to assign a Hold investment rating to Balchem’s stock. BCPC’s forward P/E valuation is reasonably fair, which is reflective of the upside potential of the company’s inorganic growth developments, and the downside risks relating to its short-term profitability.

Recent M&As Will Boost Growth Of Core Human Nutrition Business

On August 30, 2022, Balchem revealed that it had bought over Bergstrom Nutrition. In the announcement, BCPC describes Bergstrom Nutrition as a producer of MSM” or methylsulfonylmethane, which is a “nutritional ingredient” that boasts “benefits” in areas such as “joint health, sports nutrition, skin and beauty, healthy aging, and pet health.”

Bergstrom Nutrition is Balchem’s second M&A transaction in the year. BCPC had disclosed earlier on Jun 21, 2022 that it concluded the takeover of Kappa Bioscience AS. Balchem called Kappa Bioscience “a leading science-based manufacturer of specialty vitamin K2” that supports “bone health, heart health, immunity, and athletic performance” in its announcement.

It is noteworthy that both Bergstrom Nutrition and Kappa Bioscience will operate under Balchem’s core business segment, Human Nutrition & Health. The Human Nutrition & Health business is BCPC’s largest segment in terms of both top line and earnings contribution. According to Balchem’s Q2 2022 earnings press release, the company derived 55% of its revenue in the first half of this year and 57% of its 1H 2022 profit before tax from the Human Nutrition & Health business segment.

Human Nutrition & Health was also the fastest growing business for Balchem in the most recent quarter. BCPC’s Human Nutrition & Health business’ segment revenue grew by +18.1% YoY in Q2 2022, while its Animal Nutrition & Health and Specialty Products businesses segments delivered relatively more modest YoY top line expansion rates of +14.9% and +7.7%, respectively. As such, it makes sense that Balchem has decided to focus on M&A for its core Human Nutrition & Health segment to further boost the growth prospects of this business.

Specifically, Kappa Bioscience is operating in a market of decent size with strong growth potential.

At the company’s most recent Q2 2022 results briefing on July 29, 2022, Balchem highlighted that the current size of the global K2 market is around $175 million and Kappa Bioscience has a 30% share of the worldwide K2 market. In comparison, the size of the global human choline (another key product for BCPC’s Human Nutrition & Health business) market now is relatively smaller at $50 million.

In its Q2 2022 earnings presentation slides, BCPC also mentioned that K2 is a fast-growing market that is expected to expand from $175 million now to as large as between $250 million and $300 million in 2025. As Kappa Bioscience is traditionally strong in Europe, there is room to increase the penetration rate of Kappa Bioscience’s K2 products in the US (BCPC’s home market) with the support of Balchem.

Separately, Bergstrom Nutrition appears to be the outright leader in the MSM industry. On its corporate website, Bergstrom Nutrition emphasizes that it is the “leading manufacturer of MSM” globally, and notes that it was the company which “pioneered the use of MSM for animal and human health use.”

In a nutshell, it is reasonable to conclude that Balchem has done two very good acquisitions. More importantly, it is reassuring to know that BCPC is very selective when it comes to M&A targets and price discipline is a key component of its acquisition process. Balchem had stressed at its Q1 2022 investor call in late-April that it is “very disciplined in” the “evaluation of purchase price and risk”, and it highlighted that “nothing (M&A deals) has closed over the last 2 years” despite the fact that it continues “participating and identifying the right targets.”

Higher Costs Expected Due To Inflation And Acquisition Debt

In the preceding section, I discussed how Balchem’s recent acquisitions could be supportive of the medium-to-long term top line growth for the company’s Human Nutrition & Health segment. However, BCPC’s profitability in the short term could possibly be affected by an increase in operating expenses and interest costs.

As per the Wall Street’s consensus financial estimates taken from S&P Capital IQ, Balchem’s normalized net profit margin is expected to decrease from 15.1% for Q3 2021 and 14.6% for Q2 2022 to 14.2% in Q3 2022. The company’s normalized net profit is projected to improve to 14.5% in Q4 2022, but this will be still lower than the 14.6% normalized net profit margin Balchem achieved for both Q1 2022 and Q2 2022. In my opinion, Balchem’s actual profit margins in the second half of the year might be even lower than what the sell-side analysts are currently expecting.

With regards to operating expenses, BCPC noted at its most recent quarterly results call that the company’s “overall spend” has “continued with slight inflation sort of month-over-month, quarter-over-quarter” with “a similar trend for July.” At the same time, Balchem also acknowledged at the company’s second-quarter investor briefing that “we need to obviously be cognizant of getting to a point where you might see some demand destruction.” In other words, BCPC’s operating costs are still gradually rising due to inflation. While cost pressures are offset by price hikes to some extent, there is a limit as to how much Balchem can raise prices without hurting its sales. This is indicative of some degree of margin pressure for BCPC in the latter half of this year.

In relation to financing costs or interest expenses, it is relevant to observe that Balchem’s leverage ratio, or net debt-to-EBITDA, increased from 0.3 times as of end-Q1 2022 to 1.8 times as of June 30, 2022. This is mainly attributable to acquisition debt associated with the buyout of Kappa Bioscience. As Balchem didn’t disclose the terms of the Bergstrom Nutrition M&A deal, it is uncertain if that also involved debt financing, which might result in a further increase in BCPC’s leverage ratio. This will naturally translate into higher interest costs for Balchem. On the positive side of things, BCPC highlighted at its Q2 2022 earnings call that “we’ll delever the 1.8 times net debt leverage that we have at the moment pretty quick here with the cash that we’re generating.”

Concluding Thoughts

I still have a Neutral view and Hold rating for Balchem. I see the positives relating to BCPC’s recent deals, but I am concerned about the potential rise in costs and resulting lower profitability for the company in the very near term. Also, Balchem’s valuations appear to be fair and unattractive. According to S&P Capital IQ’s valuation data, BCPC currently trades at 29.8 times consensus forward next twelve months’ normalized P/E, which is quite rich in absolute terms but on par with its 10-year average forward P/E multiple of 29.6 times.