Welcome to Ask the analyst, where I put questions from myself and Morningstar users to our equity research team. If you have a question about an ASX company or industry we cover, please send it to [email protected] for consideration.

Today’s edition features some questions I had for our industrials analyst Esther Holloway regarding Redox (RDX). We’ll get onto my questions shortly. But, as always, let’s start with a quick review of how Redox makes money.

A relatively simple business to understand

Redox is not a hard business to understand. It sources chemicals, ingredients and other industrial inputs from its network of 1000+ suppliers and delivers them to its clients in hundreds of sub-industries including animal nutrition, crop production and plastics.

Funnily enough, I used to work at a similar business in a different field. As a seafood trader I would buy container loads of shrimp, fish and frog legs from suppliers in Asia and sell them straight to whichever client that had placed the order.

My employer didn’t produce the product or even see it. We just added a margin for taking care of the sourcing, logistics and payment terms. In this sense, both my old employer and Redox are predominantly working capital businesses.

Most of the firm’s assets aren’t tied up in factories, warehouses, et cetera. Instead, the balance sheet is made up mostly of current assets and liabilities like accounts payable, accounts receivable, and inventories.

The basic idea here is to compound sales, profits and book value over time by making profitable deals, getting paid for them, and reinvesting the proceeds into further profitable deals. And Redox has been phenomenally successful at doing this.

Over the thirty years to June 2024, its revenues grew at an average rate of 12% per year. It is now Australia’s largest chemicals distributor by revenue, with sales of around $1.1 billion and after-tax profits of roughly $90 million in fiscal 2024.

I have, however, kept the most important fact about Redox for last. Even after the 2023 IPO, roughly 70% of the shares are held by the founding family. The family also provides two of the five board members, one of which is the company’s CEO.

My first question, then, was how Redox’s family management and ownership has influenced the way it goes about things.

How does family ownership impact the way that Redox operates?

Family controlled companies often have a reputation for being 1) longer-term oriented and 2) more conservative in how they finance the business to chase growth. I wanted to know if this has been the case with Redox.

As it turns out, Redox appears to be something of a poster child in this regard. And Esther pointed to several ways that a long-term focus has influenced capital allocation and strategy at the company.

Let’s start with its financial position. Redox has traditionally been debt-free and had around $170 million in net cash as per its latest numbers.

Sure, they could probably have grown faster at times by levering up a bit. But staying debt-free 1) made them more creditworthy to suppliers and 2) helped them survive rough patches that killed off indebted competitors.

This can lead to windfalls of new business and, over time, compound Redox’s reputation as a reliable partner in good times and bad. Another example of forgoing extra profit or growth today for long-term gains comes from the pandemic.

As lockdowns put pressure on global supply chains, Redox decided to hold more products in inventory than usual (meaning more operational costs, pricing risk, et cetera) to boost availability for clients and protect its vital buyer relationships.

Esther points to Redox’s acquisition activity as a further sign of its patience. This, she says, is not a hurried roll-up job. Instead, it is a slow and highly selective approach to deals that bring on new customer relationships without requiring too much capital.

While it could be tempting for Redox to try and excite investors by making a chunky acquisition in the US to fast-track growth in this market, Esther says the company are wary of overpaying and would rather take a slow and steady approach.

No moat, but sticky customers?

Redox has generated strong returns on capital for many years and Esther expects this to continue. However, she puts this down to Redox’s capital light business model rather than a structural advantage.

This explains Esther’s No Moat rating for Redox, and it makes sense. Redox sells commodity inputs to its clients in a way that, in theory, anybody with a telephone and the patience to build up a book of suppliers and customers could replicate.

What to make, then, of Redox’s supernormal ability to hold onto its customers?

Redox has previously claimed customer retention rates (as a percentage) in the nineties and annual churn in the low single-digits. Those are the kind of numbers you usually hear about in a software product or other business with switching costs.

Esther’s rationale for this? Good old dependability. Redox has shown that it can be relied on by clients (and suppliers) to deliver on its promises. Even through extremely trying times for its key markets and the global economy more generally.

This customer stickiness rings true from my brief stint in the seafood trading world. It was very hard to win first-time business and convince a buyer to try your company rather than sticking with the suppliers they already trusted.

This could help explain why Redox’s customer base seems extremely loyal to the company, even though they aren’t generally locked in by long-term contracts.

Is continued double-digit growth realistic?

This is the million-dollar question, and Esther is optimistic that Redox can pull it off.

The Aussie chemicals market, she says, is highly fragmented with around 2500 companies vying for share. Even as the biggest fish in this pond, Esther estimates that Redox has just 5% of the overall market, leaving it plenty of room to grow.

Meanwhile, the industry is consolidating as smaller players exit amid higher regulatory and compliance burdens for importing, moving and storing chemicals. This dynamic could continue to hand Redox more market share simply by staying put.

Redox’s huge product range (5,000+ SKUs at the last count) also presents an opportunity to increase ‘wallet share’ with existing customers by selling them other products they need for their business.

Meanwhile, Redox has slowly but surely broadened this product offering to serve customers from new sub-industries. And let’s not forget, further acquisitions to bring new customer relationships, suppliers and business on board are also likely.

What about the US expansion?

As I hinted at earlier, geographical expansion is another cog in the wheel. Roughly 10% of revenue currently comes from the US, with Redox eyeing further growth in what is the world’s second biggest chemicals market.

Esther says that Redox is taking a typically long-term approach here.

Most of its US business to date has been lower margin work with large customers in the energy drinks industry. Management hopes that by building a reputation through this, it can win more profitable business with smaller buyers over time.

Taken together, Esther thinks that the odds of Redox continuing to grow sales at a double-digit clip look fairly good.

Her forecast, which values the company at $4.40 per share, relies on 10% annual growth for the next decade and gross margins resembling their historic average of around 21%.

Bonus question: Why is it public at all?

One question I kept coming back to is why Redox is public at all.

The family don’t seem like they want to move on from the business or sell their shares. So it wasn’t a so-called liquidity event. Being public could also bring pressure to abandon elements of the family’s long-term philosophy.

To answer this question, Esther pointed me to the following paragraph from Redox’s IPO prospectus document:

“The purpose of the Offer and listing on the ASX is to position Redox for success over the long term for a large and growing family shareholder base who are reliant on a steady and strong dividend income stream and to protect the long-term interests of all family shareholders through public market investor oversight, ASX governance and capital management regulations and an independent Board structure.”

I don’t know about you, but that would seem to suggest that Redox’s family ownership and long-term approach to business are here to stay.

If you are an investor that values management-shareholder alignment and is seeking a long-term income play, I can think of worse places to look.

Redox

  • Moat Rating: No Moat
  • Fair Value estimate: $4.40 per share
  • Star rating: ★★★★★

Remember: Before you get to choosing investments, we recommend you form a deliberate investing strategy. You can read more about how to form your strategy here.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.