From time to time, we highlight specific companies which we believe fit the profile of a classic Taylor Frigon growth company. These companies meet the criteria outlined by Thomas Rowe Price, Jr., in his 1973 circular "A Successful Investment Philosophy based on the Growth Stock Theory of Investing," which recommended investors seek out businesses with "capable, dynamic management operating in a fertile field for future growth." Previous posts discussing companies which meet these two broad criteria of good leadership and fertile fields for future business growth have included examinations of QuickLogic (QUIK), Amphenol (APH), and Tractor Supply (TSCO).*
Today, we will briefly examine specialty chemical supplier Balchem (BCPC).* Chemical companies are often extremely cyclical in nature, with both revenues and earnings fluctuating wildly based on the overall economic conditions or on cycles in their specific underlying markets (such as agricultural crop demands). This extreme cyclicality generally means that investors in chemical companies must be able to "get in" and "get out" at the right times (timing the market conditions), because simply owning the stocks of these companies for a long period of years will result in a lot of ups and downs with little actual net long-term growth. Trying to time markets is the very antithesis of the long-term growth strategy articulated by Mr. Price and the version of that strategy followed by Taylor Frigon Capital Management (for previous posts discussing this distinction further, see for example here and here).
In contrast to many other chemical companies, Balchem has achieved remarkably steady and consistent growth, due to a variety of factors. First, the company's products are put to use in applications which serve some very distinct end-markets, such that their business has a good degree of market diversification. Second, Balchem has unique production capabilities involving products that practically no one else supplies to their markets, as well as involving technologies such as micro-encapsulation which make their chemicals more useful and valuable than they might be without encapsulation. Third, Balchem's products address numerous market applications in areas which could be characterized as "fertile fields for future growth."
Balchem is the largest producer of the chemical choline chloride, a source of the necessary nutrient choline, essential for brain and nervous system health in humans and for physical growth in chickens and pigs, which are raised worldwide as a source of food. Choline is also beneficial to the health and milk production of dairy cows during lactation, but it must be encapsulated in order to pass all the way through the cow's multiple stomachs to the intestine where it can be absorbed into the bloodstream. The sale of choline chloride to agricultural customers makes up the largest portion of Balchem's revenues, at about 46% of the company's trailing twelve-month revenues (split between choline for poultry and for pigs at about 33% of the total trailing twelve-month revenues and encapsulated choline for dairy cows at about 13% of the company's trailing twelve-month revenues).
The company believes that the use of encapsulated choline for dairy cows is a relatively new application and that there is plenty of room for growth as the benefits of choline for lactating cows becomes more widely understood and adopted.
Balchem also supplies ethylene oxide gas and propylene oxide gas, which are specialty chemicals used to sterilize surgical equipment prior to surgeries (ethylene oxide) and to kill bacteria, mold and insects in nutmeats (primarily almonds) prior to being sold for human consumption (propylene oxide). Of these two gases (propylene oxide and ethylene oxide), Balchem is the sole US supplier of ethylene oxide gas, which is one of three methods which hospitals can select for the sterilization of surgical equipment, competing with sterilization by radiation or by contact with extremely hot steam. Of these, ethylene oxide is the most popular, followed by radiation and finally steam (steam is least convenient because in the other two methods the surgical tools can remain wrapped in their protective plastic tray-wrap, while in steam disinfectant they cannot). Ethylene oxide is increasingly more convenient than radiation because radiation cannot be used on a tray of equipment if there is any plastic component in any of the pieces of equipment -- if so much as a single screw on a pair of surgical scissors on the tray is made of plastic, then radiation cannot be used on that tray. Since plastic is generally less expensive than metal, manufacturers increasingly want to include plastic parts in surgical tools. There are also demographic drivers which generally increase the number of surgeries which are performed, as populations age in the developed world.
Balchem products are also used in the preparation of food for human consumption and as supplements for wellness. Choline is part of the B-family of vitamins and has been shown to contribute to normal liver function, normal metabolism of lipids by the body, and the maintenance of normal levels of homcysteine (an amino acid). It is necessary for the development of the brain and nervous system in infants and may also help prevent Alzheimer's and other dementia diseases. While choline is found naturally in many foods such as green leafy vegetables, adults who do not eat enough of these foods may benefit from choline supplements.
Finally, choline chloride is also used as a clay-swell inhibiting agent in hydraulic fracturing, which has seen rapid growth in the United States for retrieving oil and natural gas from shale deposits (see chart above for the natural gas production from the Marcellus Shale in the northeastern United States since 2000). Approximately 25% of Balchem's trailing twelve-month revenues now come from industrial applications of choline for uses such as hydraulic fracturing. Because choline is non-toxic (in fact, it is actually beneficial to human health), it can be preferable to competing products which could also be used to prevent the swelling of shale clay during mining operations, such as potassium chloride (KCl).
We believe that Balchem exhibits many of the qualities of a classic Taylor Frigon growth company. The company also recently initiated a dividend, which they have subsequently raised successively.
* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by Amphenol (APH), Balchem (BCPC), QuickLogic (QUIK), and Tractor Supply Company (TSCO).
