3 Simple Reasons I Like DGL Group (ASX: DGL)

Given that a rising rate environment has made it a lot harder to make money investing in asset light growth stocks, in the short term, I’ve been more interested in companies that have tangible assets. Put simply, in an inflationary environment, the price of assets is going up in dollar terms, and one way to protect yourself in that environment is to own valuable assets produce something.

Now, it is crucially important that the ‘something’ produced be in short supply, with reasonably inelastic demand. In that scenario, the price will simply be increased. Meanwhile, the plant and equipment used to produce the something will be more expensive today, relative to when it was built. That (in theory) makes new competition less likely. For example, in the semiconductor space AMD (a chip manufacturer) is showing share price resilience, and so too is Applied Materials, a company that makes the machines that manufacture chips.

Of course, we don’t have a chip manufacturing industry in Australia, but we still do have some less sophisticated manufacturing companies, such as DGL Group (ASX: DGL).

What does DGL Group do?

DGL Group is a roll up of chemical fabrication, distribution and remediation companies. That means it can supply toxic chemicals used for industrial purposes in a legally compliant way. In this scenario, regulation is actually a good thing for society, because otherwise poisons would be dumped in our waterways. But that regulation creates the need for specialisation, and DGL group is that specialist. DGL makes and distributes a wide range of products such as water treatment chemicals, coolant for cars, and the Adblue additive that is used to make diesel fuel less polluting.

Why Do I Like DGL Group?

The first reason I like DGL Group is that its founder Simon Henry owns over 50% of the company, and still spent another $500,000 or so buying shares at around $2.80, in mid December 2021. Arguably, this may indicate he thinks his company’s $1 IPO price was way too low. Although he did not sell any shares into the float, it’s still strange to see a CEO buy a meaningful chunk of shares at so far above the price that he recently diluted himself at.

The second reason I like DGL Group is that the company has substantial plant, property and equipment worth about $133 million, so there are very real very physical assets that will become more expensive to replicate, in an inflationary environment.

The third reason I like DGL Group is that it is Australia’s largest producer of AdBlue, which was reported to have quadrupled in price (in some areas) in mid December 2021. Now, part of the reason for the shortage of AdBlue was a lack fo Urea, so increasing input prices explain part of the price rise. But the fact that these price rises were passed on to the consumer, even despite accusations of price gouging, suggests that DGL Group has pricing power in this product, in Australia.

What Are The Negatives About DGL Group?

Of course, no company is without its negatives. The company made a pro formal net profit after tax of $11m in FY 2022 and its current market cap is about $810 million, putting the company on a shocking P/E ratio of 73. According to S&P capital IQ, estimates are for profit of about $18 million in FY 2022, which is still 45 times earnings, for a roll up. Basically, I don’t think that the stock is particularly cheap.

Nonetheless, DGL Group seems to have a traditional “moat” business, with the potential to grow its reach, and perhaps reduce competition, by acquisition. With a tight share register and some growth potential, there is considerable upside if the company ever gets to the size and liquidity that justifies entry into the ASX 200. That will presumably take some years, given that so much of the stock is tightly held. However, as we have seen below, such opportunities can be very rewarding and so I cannot resist holding at least some DGL shares. And at the right price, I’d buy more.

This is very far from a fully fledged investing thesis for DGL Group, but I thought it was about time I jotted down some thoughts about why I hold the stock; lest I forget myself, with the passage of time! At the end of the day, I think it is a company that could be worth following, but I’m not too excited about the price.

I am somewhat hopeful that the company will exceed market expectations in FY 2022, and provide an opportunity for me to sell at higher price. Alternatively, if the company performs well but the price doesn’t move I might just hold on. If the company disappoints, I would probably sell at a loss. For me, my DGL Group shareholding is designed to keep me interested in what could be a long term growth story, from an early stage.

Please remember that these are personal reflections about a stock by author. I own shares in DGL Group, and I won’t sell them for at least two days after writing this article. This article should not form the basis of an investment decision. It is an investment diary valuable only for the cognitive process it demonstrates. We do not provide financial advice, and any commentary is general in nature. Please read our disclaimer.

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