Agrochemical And Semiconductor Demand Will Drive A Stronger Long Term Outlook

Catalysts

About Adeka

Adeka is a diversified chemical and food products company with operations spanning polymer additives, semiconductor materials, environmental materials, food products and life science, including agrochemicals.

What are the underlying business or industry changes driving this perspective?

• Expansion of data centers and devices equipped with generative AI is supporting strong demand for advanced semiconductor lithography materials for photoresists. This can lift Semiconductor Materials segment revenue and, as pricing stabilises, help operating profit.
• Global demand for fuel efficiency in mobility is supporting strong sales of lubricant additives for engine oil in Asia and the US. This can underpin revenue growth in Environmental Materials and gradually support net margins as volumes scale.
• Rising rice prices in Japan and increased rice acreage are supporting strong sales of herbicides and insecticides. This directly supports Life Science segment revenue and has already contributed to higher operating profit.
• Broader use of herbicides and acaricides in North America and Europe for wheat, rapeseed, fruit and potatoes is supporting volume growth in agrochemicals. This can help sustain earnings and offset weaker areas such as Polymer Additives.
• A company wide focus on global sales expansion of new products, including the new clarifier in Polymer Additives and stepwise launches in Semiconductor Materials, is aimed at lifting net sales and, if volumes improve against fixed cost levels, supporting earnings and ROE targets.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more optimistic perspective on Adeka compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming Adeka's revenue will grow by 6.9% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 6.7% today to 7.3% in 3 years time.
• The bullish analysts expect earnings to reach ¥37.2 billion (and earnings per share of ¥366.81) by about July 2029, up from ¥27.9 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as ¥31.4 billion.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 15.0x on those 2029 earnings, up from 14.8x today. This future PE is greater than the current PE for the JP Chemicals industry at 13.6x.
• The bullish analysts expect the number of shares outstanding to decline by 3.81% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.27%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The Semiconductor Materials business is already facing a steep decline in net sales and operating profit as legacy high k products are hit by production adjustments during the DRAM generational change. If the transition to new products is slower or less profitable than expected, this could weigh on revenue and earnings.
• Polymer Additives has recorded a slight decline in net sales and a steep decline in operating profit due to weak demand in home appliances and automotive related engineering plastics, plus adverse net pricing and an unfavorable exchange rate. If these conditions persist it could continue to pressure net margins and operating profit.
• Life Science currently offsets weaker Chemicals and Food Products results, but some agrochemical demand was pulled forward ahead of U.S. tariffs and management expects lower sales in the second half with higher fixed costs. If underlying demand normalizes at a lower level than the first half, revenue and earnings could soften.
• The Food Products segment is already seeing weaker sales of shortenings and margarines as customers in China focus on low prices during an economic downturn. If this price sensitivity continues or spreads, it could limit pricing power and contribute to lower net sales and thinner net margins.
• Management itself highlights that, even with an expected recovery in the second half of fiscal 2025, Semiconductor Materials and Polymer Additives are unlikely to fully offset the first half shortfall. If higher fixed costs and unfavorable exchange rates continue at the same time, this combination could cap progress toward the JPY 53b operating profit and 11% ROE goals, limiting earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Adeka is ¥5490.0, which represents up to two standard deviations above the consensus price target of ¥4698.33. This valuation is based on what can be assumed as the expectations of Adeka's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ¥5490.0, and the most bearish reporting a price target of just ¥3200.0.
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be ¥509.1 billion, earnings will come to ¥37.2 billion, and it would be trading on a PE ratio of 15.0x, assuming you use a discount rate of 5.3%.
• Given the current share price of ¥4253.0, the analyst price target of ¥5490.0 is 22.5% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.