Legendary investor Warren Buffett often talks about the idea of a business having a ‘moat’ – something that helps a firm keep its competitors at bay. That concept of a moat is one of the things that attracted me to add FTSE 250 share Victrex (LSE: VCT) to my portfolio.
On top of a moat, Victrex now also boasts a 6.1% dividend yield. But despite the apparent attractions, the price has fallen 55% over the past five years.
So, is this a bargain hiding in plain sight – or does the steep fall potentially point to deep-rooted problems?
Proven business model, little-known name
I think it is fair to say that if I asked people walking down the street if they had heard of Victrex, most of them would say no. But a fair number of those people would have used its products, whether they realised it or not.
The polymers that Victrex manufactures are used in applications from cars to planes. Such markets require total quality, meaning that Victrex has pricing power. On top of that, it has some proprietary products. Taken together, that helps give the company a moat.
Such pricing power can support profits – and dividends. With a yield well above the FTSE 250 average, Victrex is certainly delivering on that front, at least, at the moment.
Tough times for the stock
With all that going for it, then, why has the Victrex share price been on a downward spiral in recent years?
A quick look at the company’s interim results back in May helps paint the picture. Sales volumes were down 11% year on year, while revenues declined even more at 14%.
Even worse (by far), profit before tax crashed 92%. The interim dividend was held flat, but if profits do not recover sufficiently, surely there must be some doubt over the long-term future of the dividend?
The reason for that fall in earnings was given as trading and asset utilisation, alongside exceptional items. The point about asset utilisation underlines that Victrex has high fixed costs, so filling its production lines makes a big difference to profitability.
While the exceptional items will hopefully not recur, clearly Victrex faces multiple challenges in its ordinary course of business. Although it said it saw continued momentum in its most recent quarter, the firm also noted that sentiment across the chemical sector remains “mixed”. Between soft demand, ongoing high energy costs and weak demand with medical clients, I think the outlook remains tough for Victrex.
Why I am hopeful
Like Buffett though, I invest for the long term.
The business environment for Victrex remains challenging. But the underlying business is strong in my view and that moat and pricing power are key. Plu it is in an area in which I expect to see long-term demand from customers who are willing to pay for quality.
I think the FTSE 250 share has fallen due to short-term business challenges. I believe it is undervalued — and plan to keep my shares.
The post 6.1% yield and a wide moat! Why has this FTSE 250 share fallen over 50%? appeared first on The Motley Fool UK.
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C Ruane has positions in Victrex Plc. The Motley Fool UK has recommended Victrex Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
