LONDON: The companies most clearly aligned with fixing the future and financial gain are those that sell products to make their customers’ activities more sustainable. This confluence of purpose and profit is a major reason for the popularity of Swiss construction chemicals giant Sika with many of the world’s best fund managers. The 112-year-old company’s products are helping to reduce the impact of some of the world’s most carbon-intensive industries while also growing its bottom line.

10 largest* elite manager holdings

Elite manager	Fund	Weighting (%)	Portfolio Rank
Marc Possa	SaraSelect	6.1	2 / 38
Giles Rothbarth & Stefan Gries	BlackRock Continental European Fund	6.0	3 / 36
Urs von Arx	UvA Swiss Dividend Fund	5.9	6 / 24
Daniel Häuselmann & Thomas Funk	GAM Multistock Swiss Equity	5.2	4 / 40
Franz Weis	Comgest Growth Europe Opportunities	5.1	5 / 41
Marcus Morris-Eyton	Allianz Europe Equity Growth	5.1	4 / 49
Sharon Bentley-Hamlyn	TreeTop Global Aubrey European Cvc	4.8	2 / 41
Patrick Hasler	Migros Bank (Lux) Fonds SwissStock	2.9	10 / 105
Carlos Moreno & Thomas Brown	Premier Miton European Opportunities Fd	2.7	9 / 49
Carl Auffret	DNCA Invest SRI Europe Gr	2.4	18 / 35

*based on portfolio weighting

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The business case for going green has not always been as clear cut for Sika as it is today. The sustainability agenda was originally pushed by Sika’s once-powerful founding family. When the company launched its ‘more value, less impact’ strategy in 2013, management had to find a way to make its environmental ambitions work commercially.

‘We started to do customer audits, which really confirmed to us that they didn’t buy into sustainable products. They wanted performance. And so, this is why we made it that products must be more sustainable and better performing. Only then did customers start buying more sustainable products,’ says Dominik Slappnig, head of Sika investor relations. ‘That was five years ago. Now the momentum has changed.’

As well as requiring that all launches offer both higher performance and additional sustainability benefits, Sika aims to generate a quarter of sales each year from new products, which it defines as products less than five years old. Together, these aims help ensure a constant flow of green innovation as well as performance improvements.

While it may not have been the result of commercial clairvoyance, Sika now finds itself at the forefront of rapidly emerging growth trends linked to its customers’ increased focus on environmental issues, encouraged by tightening regulation.

What was previously hard to sell is now an important competitive edge.

Products that fix the future

Sika is a leader in products for bonding, sealing, damping, reinforcing and protecting. It has subsidiaries in 101 countries, operates more than 300 factories and employs more than 27,000 people.

Its two key end markets, the building sector and motor vehicles, are in industries estimated to account for more than 60% of energy-related Greenhouse Gas (GHG) emissions.

Here are a few examples of Sika products with stand-out sustainability benefits:

• Sika has developed an admixture that slows concrete drying time to allow high-rise buildings to be built around a concrete core rather than a steel one. This improves safety and reduces GHG emissions.
• The company has developed a full recycling method for concrete called reCO2ver.
• An additive for cement has been developed that can reduce CO2 emissions by replacing up to 50% of clinker. Clinker is powdered limestone that emits high amounts of CO2 when produced.
• Products for roofing and walls aim to reduce energy loss while helping to control temperature and cut the use of air conditioning and heating.

With most companies now looking beyond the factory gates to assess their environmental impact, the sustainability of Sika’s own production techniques also represents an important selling point for customers. Internal targets include lowering CO2 equivalents per ton of goods sold by 12% to 2023 and reducing both water consumption and waste per ton by 15%. Meanwhile, group- and senior-manager incentives are linked to GHG targets.

Making the most of it

While the structural trends powering demand for Sika’s products are very positive, most of the group’s end markets are well established. This means overall market growth is expected to prove impressive but not breakneck. Sika predicts its addressable market will increase in size from CHF 70bn (£57bn) in 2021 to CHF 80bn by 2025, a 3.4% compound annual growth rate. But there are several levers Sika is pulling to help it better this.

Sika’s markets are fragmented. It has a 10% share and the top-10 players have only 40% between them. Helped by product innovation, scale advantages and its global distribution networks, it thinks it can lift its share to 12%.

Product innovation will play an important role in boosting share. This is reflected in healthy levels of research and development (R&D) spending, which have averaged 9% of gross profit over the past five years, backed by a steady flow of new patents, including 99 last year. The relatively simple chemistry behind most of Sika’s products means its sharp focus on patent protection is crucial to creating value.

Acquisitions also play an important role in driving growth. Sika tends to buy relatively small businesses that can be easily integrated and benefit from its international infrastructure and a shared cost base. Such deals, of which there were seven last year, are also used to move into new product areas and enhance sustainability credentials.

However, the group sometimes goes large with acquisitions. It expects to complete its biggest ever acquisition in the second half of the year, the CHF 5.5bn purchase of MBCC. Improving the sustainability of products is a particular attraction. MBCC estimates that its products on average reduce customers’ GHG emissions by about half compared with alternatives. Sika is currently working on its own estimates of product impact and hopes to be comparable with its acquisition target.

Large acquisitions always carry extra risk based on the complexity of integration as well as the amount of cash on the line. The strategic fit between Sika and MBCC is considered good, though, and CHF 160-180m of annual cost savings have been identified.

‘Sika has integrated its acquisitions well historically and has executed its growth strategy without diluting shareholders, through a combination of high levels of internally generated cashflow and manageable levels of debt,’ says Sharon Bentley-Hamlyn, elite manager of the TreeTop Global Aubrey European fund.

Net debt to earnings before interest, tax, depreciation and amortisation (Ebitda) of 1.4 times is well down from the 3.4 times it hit in mid-2019 after its last big acquisition, which was the CHF 1.2bn purchase of Parex. Debt levels are expected to rise to about 3.5 times Ebitda again once MBCC is paid for.

Riding megatrends

Sustainability sits alongside several other megatrends that Sika expects will power its growth over coming decades.

Urbanisation is driving demand for many of Sika’s products. The percentage of people living in cities is forecast to increase from 56% today to 70% by 2050. This is influencing spending on new buildings and infrastructure in developing countries, and refurbishment and repurposing in rich countries.

The company believes its efforts to create innovative building methods, such as 3D concrete printing and other modular construction methods, play to demographic trends. Specifically, it believes it can help address the decline in working age population. Workers per pensioner are expected to halve from eight to four between 2017 and 2050.

Emerging prosperity is considered another key opportunity, especially as nearly two fifths of Sika’s sales are generated from emerging economies. These markets often have weak environmental regulation, which makes Sika’s sustainability commitments more impactful.

Pricing power

Acquisitions and innovation have contributed to a gradual improvement in Sika’s margins as well as its top-line growth. Last year’s operating margin hit the milestone of 15%, which is almost double a post-credit-crunch nadir. From here, Sika reckons margins could head towards 18%, with 15% representing a new bottom end of the range.

‘It would be a stupid thing to grow but not to grow your profitability,’ says Slappnig.

As well as the deep-rooted focus on sustainability, brand allied with high levels of customer service are important in supporting pricing power. The company still uses branding devised by its founder, which helps quickly build trust in new products. 

The company is confident in its ability to pass on recent raw material price increases. This is helped by the fact it sells what Slappnig describes as ‘salt and pepper’ products – the price represents a very small portion of total costs, but the contribution is very noticeable.

Also driving margins is management’s target for an annual 0.5 percentage point fall in cost relative to net sales, independent of material cost changes.

There are a lot of little things going on. Together this has resulted in excellent incremental progress for shareholders. Brokers forecast this will continue.

Family rows and Europe’s nastiest takeover battle

Sika was founded by plasterer-turned-inventor, Kaspar Winkler, in 1910. His son-in-law, Fritz Schenker, and then Schenker’s own son-in-law, Romuald Burkard, took the business to new heights. Along the way Sika survived a brush with insolvency in the 1960s and was floated in the late 1970s. Burkard also instilled the idea of the ‘Sika spirit’, which framed the organisation as first and foremost a community of people rather than a company. The founding family also helped put ideas about sustainability at the company’s heart.

But the close relationship with the founding family ended acrimoniously in the 2010s in what The Economist dubbed ‘Europe’s nastiest takeover battle’.

In 2014, family shares commanded six times the votes of outsiders’ shares. This meant the family’s 16% holding gave it more than half the votes. Winkler’s heirs offered this holding to French rival Saint-Gobain for CHF2.7bn. Sika’s articles of association meant Saint-Gobain did not need to make any offer to other shareholders, which essentially hung them out to dry.

The back-room deal caused consternation from all quarters. The shares fell 30%.

The downfall of the family’s plan to sell was the checks and balances their forebears had placed within the articles of association. The circumstance of the takeover allowed the company’s non-family directors to restrict family voting rights to 5%. It took a near two-year legal battle to establish this, accompanied by hostility and outrage all round.

It was a sad end to what had once been a prosperous relationship between an earlier generation of the founding family, management and independent shareholders. For today’s investors, though, it means a far more conducive share structure.

Great… but how great?

One noteworthy feature of the holdings in Sika of the elite managers we follow is that there have been few signs of buying this year. One reason may be the incredible valuation the shares hit at the end of 2021. Shares finished the year changing hands at about 47 times forecast earnings for the next 12 months.

That multiple compared with a forward price-to-earnings (PE) ratio of 14 10 years earlier. There is little doubt there have been significant improvements from both an operational and growth perspective over that period. But still… 47 times earnings.

There has been a major valuation rethink in 2022. 

‘The share price has seen a pullback of nearly 30% in 2022 and, despite a much higher PE today than [when we first bought] in 2010, at 33 times prospective earnings for 2022, it looks attractive on a two-year average forward price-to-earnings growth (PEG) ratio [price/earnings to EPS growth rate] of 1.3,’ says Bentley-Hamlyn. ‘Barring much higher than expected rises in interest rates, or a deep recession involving cutbacks in global construction, the current multiple looks defensible.’

Despite the strong long-term megatrends that Sika taps into, the dangers of a downturn should not be dismissed, especially because the fixed costs associated with Sika’s many manufacturing facilities around the globe heighten this risk.

During the great financial crisis – the last major downturn the group faced – costs of goods sold as a percentage of sales rose from 69.9% before the crisis to 73.5% in the company’s trough year of 2011. That may not seem a big move on the surface, but as the ramifications worked their way down the company’s profit and loss statement, it resulted in a near two-fifths decline in Sika’s after-tax profit margin over the period, from 7.6% to 4.7%. But that’s ‘operational gearing’ for you.

But taking the longer-term perspective, the focus on offering customers solutions for their sustainability needs with patented innovations while growing profitability represents a very attractive proposition. It’s one that many of the world’s best fund managers want a part of.