Background

It must be very difficult these days to overcome the natural scepticism of investment committees about growth stories in traditional industries in the UK. They might be few and far between, but they do exist as the case of Celotex proves.

Celotex produces a type of foam board used to insulate roofs, walls and floors. It is used mainly in houses where space restrictions favour a Celotex type material over less thermally efficient but cheaper alternatives such as mineral wool. New building regulations in 2002 increased the need for insulation in houses to such an extent that there now exists a shortage of insulation material in the UK. As a result, mineral wool prices have risen dramatically, as have Celotex's sales volumes. But this is the UK building industry, so the question had to be "when will the party end?".

Approach

AMR's approach was a mixture of industry interviews and, this being such a well-documented industry, lots of desk research. Demand was clearly being driven by building regulations, but would it merely plateau at the new level? New, even tighter, regulations are due in 2006 so the answer to that was an unequivocal "no".

There seemed to be a lot of planned capacity additions, would these be a threat to future growth and profits? Discussions around the industry gave us a detailed understanding of the capacity already out there, its relative efficiency and quality and a good picture of exactly what extra would be laid down over the next three years. Fortunately for us new Rigid foam laminators have an eighteen month lead time and there are only a handful of manufacturers so we could be pretty certain our analysis was right. In any case, it soon became obvious, Celotex has a strong brand underpinned by its 80-year history. The next step in understanding the demand / supply balance was to understand demand.

One of the challenges in putting together a forecast for the business was determining exactly where the product is used. Most is sold to large distributors who sell it on to smaller distributors who in turn sell it to builders. There is no data on where builders use it. However, because it is considerably more expensive than alternative materials it is a good bet that it is only used where it has to be. Interviews soon revealed that roof, loft and partial fill in cavity walls are the main uses with repairs and extensions being more important than new build. However, the trend to higher densities means that new build is becoming more important. In high-density developments the cavities between walls cannot be excessively wide and houses are increasingly being built with a room in the roof which favours Celotex in the loft over mineral wool. Synthesizing a number of different third party forecasts gave us the volume forecast we needed.

Only raw material supplies could spoil the party now and guess what? The main ingredient, MDI, was in such short supply that manufacturers were about to start rationing it. Fed up with low prices in the past, MDI makers had put off investing in new capacity. The recent upsurge in demand also took them by surprise. Fortunately management had the clout and credibility to negotiate enough MDI over the next twelve months to meet their growth aspirations.

The deal was completed in October 2004.

"AMR's analysis of the market dynamics convinced us that this was a good deal."
Paul Moxon, ABN AMRO Capital