Tariff And Export Pressures Will Reshape Rare Earth Supply Chains Yet Eventually Support Resilience

Catalysts

About Compass Diversified

Compass Diversified owns and manages a collection of middle market consumer and industrial businesses across the U.S. economy.

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

• Although Arnold’s backlog finished 2025 more than 40% higher and quoting activity is described as at an all time high, repeated rare earth export controls out of China and ongoing tariff uncertainty could limit how much of that demand actually translates into shipped product and recognized revenue. These factors could also delay the impact of the new Thailand capacity on earnings.
• While demand for secure, non China rare earth magnet supply positions Arnold to benefit from a longer term shift toward geopolitically resilient supply chains, frequent changes in export licenses and trade rules can keep production inefficient and asset utilization below potential. This may cap improvements in subsidiary adjusted EBITDA margins.
• Although CODI has initiated multiple sale processes and describes strong buyer interest in its subsidiaries, M&A conditions that are only lukewarm and buyers’ concerns about the broader economy raise the risk that any divestitures used for deleveraging occur at less favorable terms. This would limit the reduction in leverage and the related interest expense savings in net income.
• While the Honey Pot and other branded consumer businesses are seeing healthy engagement, tariff related pressure on consumer spending and a price sensitive mid tier customer base at brands such as 5.11 could keep unit volumes subdued and force further pricing rollbacks. This would put ongoing pressure on gross margins even as CODI targets mid single digit subsidiary adjusted EBITDA growth.
• Although CODI is deploying AI and cost controls across businesses such as 5.11 to support operating leverage, the combination of higher public company costs, tariff driven input volatility and cautious CapEx plans of US$30 million to US$40 million in 2026 may slow the pace of efficiency gains. This could constrain improvements in free cash flow conversion and net margins.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Compass Diversified compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Compass Diversified's revenue will decrease by 2.5% annually over the next 3 years.
• The bearish analysts are not forecasting that Compass Diversified will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Compass Diversified's profit margin will increase from -8.0% to the average US Diversified Financial industry of 14.8% in 3 years.
• If Compass Diversified's profit margin were to converge on the industry average, you could expect earnings to reach $245.6 million (and earnings per share of $3.26) by about August 2029, up from -$143.5 million today.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 6.2x on those 2029 earnings, up from -6.0x today. This future PE is lower than the current PE for the US Diversified Financial industry at 17.8x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.72%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Rare earth export controls out of China and frequent changes to export licenses could persist as a long-term geopolitical tool. This would keep Arnold operating inefficiently and limit how much of its higher backlog and strong quoting activity actually turns into shipped product and revenue, weighing on both industrial segment revenue and subsidiary adjusted EBITDA.
• Ongoing tariff uncertainty and the broader pressure on consumer spending that management links to tariffs could keep the mid tier customer under strain at brands like 5.11 and across the branded consumer portfolio. This may require further price rollbacks and discounting and put sustained pressure on gross margins and net margins.
• If M&A conditions stay only lukewarm and buyers remain cautious about the broader economy, CODI may be forced to accept less favorable terms or slower timing on subsidiary divestitures. This would slow deleveraging from the current leverage ratio of about 5.47x and keep interest expense and net losses elevated for longer.
• Public company costs and cash fees remain significant, with guidance of US$25 million to US$30 million of cash management fees in 2026. If cost controls or AI driven efficiency do not offset this over time, these overhead costs could continue to absorb a large share of subsidiary adjusted EBITDA and limit improvements in net income and free cash flow.
• The long-term thesis depends on CODI returning to an acquire and grow model once leverage is lower and capital markets are more supportive. If credit conditions, tariff policy or investor risk appetite stay unfavorable, CODI could be restricted to balance sheet repair for longer than planned, constraining portfolio growth and keeping revenue and earnings growth closer to the current mid single digit subsidiary adjusted EBITDA outlook.

Valuation

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

• The assumed bearish price target for Compass Diversified is $15.0, which represents up to two standard deviations below the consensus price target of $17.0. This valuation is based on what can be assumed as the expectations of Compass Diversified's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $18.0, and the most bearish reporting a price target of just $15.0.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $1.7 billion, earnings will come to $245.6 million, and it would be trading on a PE ratio of 6.2x, assuming you use a discount rate of 10.7%.
• Given the current share price of $11.52, the analyst price target of $15.0 is 23.2% higher. Despite analysts expecting the underlying business to decline, they seem to believe it's more valuable than what the market thinks.
• 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.