Croda (CRDA / CRDA.L): Part 2

In Part 1, I described the key role Croda plays in the beauty industry as an enabler of indie brands. Companies like Croda have allowed actives-led indie brands to successfully compete head-on with big beauty and Croda's success has eroded many of the traditional advantages big beauty brands like L'Oréal and Estée Lauder have.

In Part 2, I describe Croda's Life Sciences business. The underlying products are driven by the same chemistries and often share manufacturing plants but the businesses are ultimately very different. Croda's Life Sciences business is in my view higher quality than Consumer Care with better longer-term growth opportunities. At the end of the report, I also do a deep dive on Croda's management, capital allocation track record, key drivers, then run through my investment thesis and valuation.

To give a quick preview of the thesis: Croda's Life Sciences and Consumer Care businesses did the same EBITA in F2024 versus F2019 whilst Croda's current P/E multiple (18x F2026) is below its long-term average (20x to 25x) even though we are likely at trough margins and on the verge of a cyclical revenue recovery. While there were clearly some missteps from 2019-24, since 2019 Croda has become the leader in excipients for mRNA vaccines via the 2020 acquisition of Avanti and has products specified into 50% of all biologic drugs in the drug pipeline. In aggregate, Croda is a better business today with better long-term growth opportunities compared to 2019. The recently execution issues and volatile trading environment has created an interesting opportunity to buy shares at an attractive valuation.

Industry Primer – Life Sciences

What are excipients? Excipients are the inactive part of a drug formulation used to stabilize, preserve or aid in the delivery of the Active Pharmaceutical Ingredient (API) to the end-patient. Within the $1.4tn pharma industry, excipients are a $15bn niche. Excipients are selected at the pre-clinical or early clinical-trial stage meaning once an excipient is specified-in and approved by the FDA, the excipients remain on that drug platform for life. An additional benefit is that once the original drug is off patent, the same excipient is likely to remain on subsequent generics leading to long-term sticky revenue.

The rise of biologics and nucleic-acids based drugs (e.g. mRNA vaccines) has increased the technology and purity requirements within excipients and represent a significant growth opportunity. Approx. 70% of the excipient market is for small molecule applications growing c.5% and the 30% is for large molecule applications growing 8% to 25% depending on the sub-segment. Below is a look at some of the applications and areas of focus for Croda. Note the TAM is for the API. The excipients TAM is c.1% of the API TAM but growing in-line with the underlying API. Generally, excipients for more advanced drugs are more complex and occupy a higher percentage of the TAM but still represents a small percentage of overall drug development costs.

Small Molecule. Small molecule drugs are manufactured via chemical synthesis. Oral dose excipients act as benign fillers and help with binding to make manufacturing cost-effective. Cellulose is a common binding ingredient where Ashland, BASF and Dow are leaders (all are also leaders in cellulose-derived personal care ingredients). The oral dose market is the largest sub-segment but only grows GDP. The market is technologically mature but it is consolidated and quality and reliability of excipient supply are far more important to price so EBITDA margins can still be high-20%’s. Small molecule injectable (parenteral) excipients are made from high purity vegetable oils and emulsifiers. Croda is the market leader in injectable excipients with an estimated c.20% value share followed by Evonik, Clariant and BASF. The parenteral market is a smaller but higher HSD growth. This market is also technological mature but requires purification expertise. Again, given excipient quality and reliability of supply are far more important to price, EBITDA margins can be high-30%’s. Finally, topical creams are a small TAM comprised of emulsifiers used to bind oil and water in creams. This is a mature technology similar to personal care where Croda, Ashland, BASF and Lubrizol are major players.

Protein Biologics. Protein APIs like hormones, enzymes and monoclonal antibodies (mAbs) are manufactured via biological means using cells, bacteria, or yeast making them highly sensitive to their environment. mAbs are a specific type of protein produced from a single clone of immune cells that can bind to a single specific target. While the underlying excipient is still based on vegetable oils and emulsifiers, the purification levels are a step-change higher. For example, excipient for protein-based biologics can cost anywhere from $100/kg to $10,000/kg versus $10/kg for small-molecule equivalent. Advanced excipients technology makes the API soluble, keeps it stable, aids absorption, and stops molecules from aggregating together. While protein-based biologics have been developed over the last 20 years, they represent the early innings into biologics with c.50% of the research, pre-clinical, and phase 1 and 2 pipelines being biologics. The market for protein and mAbs drugs is estimated to be $300bn growing 10%. Excipients for protein biologics are still a niche area where the excipients TAM is <1% of the API TAM. Croda is again the market leader where it has c.20% share where it competes against Merck KGaA, NOV in Japan, and niche regional specialists.

Nucleic Acid (mRNA). Nucleic acid-based therapies use nucleic acids like mRNA to target specific molecules to elicit an immune response, the most famous example being the Pfizer/BioNTech and Moderna COVID vaccines. The excipients are based on lipids, which are made into lipid nanoparticles (LNP) which are blended with the mRNA for transport through the body. mRNA is difficult to transport as there are enzymes in the body that destroy mRNA. A key enabler for mRNA vaccines has been the excipient used as the transport mechanisms for mRNA. mRNA materials can also be expensive so higher quality excipients can improve targeting thereby lowering the mRNA content and corresponding cost of therapies. mRNA based therapies are nascent and pre-COVID most analysts expected these drugs to come to market in the 2030s. COVID has temporarily pulled forward this timeline turning the mRNA vaccines into a c.$5bn market (of-which lipids are 2% to 5%) allowing Croda to temporarily generate c.$200m in LNP revenue in 2021 (now closer to zero). Longer-term, LNPs are poised to benefit from wider applications with analyst estimating the mRNA market could reach $30bn by 2035 (of which lipids are 2% to 5% of TAM) the majority of which will be non-COVID related.

Viral Vector Vaccine Adjuvant Systems. Adjuvants are specific types of excipients added to vaccines to boost the vaccine's immune response. They are excipients but co-function as an immune system modulator. Since the 1930’s, adjuvants for small molecule injectables were derived from aluminium salts and used in high-volume/low-value prophylactic vaccines to prevent diseases like TB and Flu. The aluminium adjuvants market is a c.$100m niche where the main players include Croda (c.30% share of volume/50% of value), Vertellus and SBI Pharma. This is a mature technology. Over the last 5 year, there has been significant innovation around adjuvants for therapeutic vaccines like cell and gene therapy. For example, GSK’s SHINGRIX blockbuster was based off a new non-aluminium-based adjuvants platform. While still nascent, Croda is working on adjuvant systems which combine LNPs with aluminium (e.g., Croda’s new adjuvant is used on the Cervarix vaccine) or newer novel molecules to create new delivery systems for new cell and gene therapy drugs.

Why is this an attractive industry? First, excipients are a minor part of drug development costs (<1%) so pharma companies have no incentive to risk the regulatory approvals and manufacturing scale-up of a new drug by choosing an unproven supplier. In other words, incumbent suppliers like Croda have a significant moat which is why excipient suppliers even in the mature oral tablets market enjoy strong margins. Second, generics companies don’t want to risk approval or speed to market by using an unproven excipient. When a drug goes off-patent, excipient suppliers may actually see a boost to growth as generic companies rush to be first-to-market so excipient suppliers face less patent cliff risk. Third, excipient companies are more likely to have exposure to an entire class of drugs versus a specific drug so they take risk at the drug-class rather than the API level. For context, Croda believes their excipients are being used in about c.50% of all biologics in the pipeline so Croda is a broader bet on the success of biologics rather than any specific molecule. Fourth, the excipient market benefits from resilient, non-cyclical growth compounded by the structural growth in biologics meaning there is a long runway to grow significantly ahead of GDP well into the 2030’s.

Why is this an unattractive industry? First, in the more value-added large molecule segment, particularly nucleic-acid-based drugs, there can be more R&D risk as many of these drugs won’t hit the market till the 2030s but require Croda to make upfront investment into R&D and manufacturing today in order to get specified into drugs in the pipeline. Second, given the growth potential and size of the nucleic acid market, there will be increased competition from traditional players like Evonik, new start-ups, as well as pharma companies themselves (i.e., GSK is developing their own vaccine adjuvant systems for therapeutic vaccines for captive use). Given the scientific complexity of drug development, it may be hard to see and catch new competitive threats in real time.

In the next section, I'll do a deep dive on Croda's Life Sciences Division followed by an analysis of Croda's management, capital allocation record, financials, key drivers, and valuation.