One of the common concerns I hear from investors regarding $ANO.AX is the difficulty in quantifying the “known unknown” probability of a competitor developing a new process to make cheaper or better zinc oxide than Zinclear. Recent headlines about research out of Imperial College London and the University of Sheffield claiming a “cheaper” and “more sustainable” method of making zinc oxide for sunscreen have set off some alarm bells that this day may have already arrived. Before hitting the panic button, let’s dive in and see how it stacks up against ANO’s mechanochemical processing (MCP) technology.
The new proposed method is “Oxidative Ionothermal Synthesis (OIS)” through which zinc oxide particles are formed by direct oxidation of metallic zinc in an ionic liquid (salt with a low melting point, in this case 1-butyl-3-methylimidazolium chloride or C4mim) mixed with water. Due to the low melting point, the desired reactions take place at relatively low temperatures (<120°C), and morphology and chemical composition can tuned by adjusting the water concentration, temperature and exposure time. Additionally, C4mim can be infinitely recycled, making for a “low cost, energy efficient synthetic approach in a sustainable medium.” This approach could also be used with other metals and ultimately lead to more cost-effective and environmentally-friendly processes for large-scale synthesis of a wide range of nano and micro materials, with physiochemical properties tailored to meet specific industrial needs.
Whereas OIS uses a “green” solvent that reduces energy requirements for zinc oxide synthesis, MCP uses no solvent at all. MCP utilizes a ball mill to grind compounds together in a salt matrix at low ambient temperatures. When the balls collide, the intensification of focal pressure and heat induces solid-state chemical reactions that create nano and micro particles. Similarly to OIS, MCP allows for a high degree of control in particle size and size distribution, as well as dispersibility, all critical properties for meeting the demands of specific industrial applications. No waste is produced in the process, but some electrical energy is required to operate the ball mill. As electrical energy can be generated by renewable sources, ultimately MCP is also a cost-effective, environmentally-friendly solution.
So if both processes cut out costly requirements for extremely high heat and are relatively environmentally benign, what’s with all the revolutionary talk? Going through the articles and research, you will see that they are only benchmarking against the industry players using vaporization techniques.
Most of the commercial zinc oxide is manufactured using the French process. In this process, metallic zinc is vaporised at 1000–1400 °C and instantly air-oxidised into ZnO powder. Due to highly nonuniform crystallization conditions, many types of one-dimensional nanostructures and irregularly shaped particles are formed. Oxidative ionothermal synthesis for micro and macro Zn-based materials
Zinc oxide is currently energy-intensive and expensive to make, requiring heating to more than 900C in a furnace, where the vapourised zinc mixes with oxygen in the air to create zinc oxide. Cheaper zinc oxide developed by UK scientists could mean end to ‘reef-toxic’ chemical sun cream
Zinc oxide is produced in two ways. Firstly, in mass, using extremely energy intensive processes creating generic materials. Secondly, using specialty smaller scale manufacturing that creates specific materials at a high cost and a large environmental footprint. Affordable reef-safe sunscreen promised by new, more sustainable way to make zinc oxide
Simply put, the omission of MCP from the discussion comes down to three possibilities: ignorance, denial, or strategic positioning. I think strategic positioning is the most likely, given that the researchers have started a company, Nanomox, and are “looking for an industrial partner to help bring the product to market.” It makes sense to frame the opportunity this way, because the broader specialty zinc oxide market large enough for multiple winners (they say £4 billion annually) and the sunscreen market is ripe for disruption, with 99% of the active ingredients being either harmful chemicals or high-cost minerals. It would be great to see this technology succeed and play a part in making the world a better place for our kids. However, as ANO investors, should we be concerned about competition from a nascent technology like this eventually eroding our own competitive moat and eating into revenue and margins?
First, let’s look at unit economics. In FY2019, ANO sold 292 MT of Zinclear to generate A$11.06m of revenue, or about A$37.87/kg. Zinclear made up 90% of product revenue, with Alusion accounting for the remaining 10%. The blended product gross margin was 52%, implying an A$18.15/kg cost of production. This is the only year of volume (MT) data we have, so we have to fill in some blanks for FY20 and FY21. My cost estimates assume a flat ASP.
In FY20, Zinclear made up 88% of product revenue, and product gross margin rose to 61%, implying a blended cost of A$14.76/kg. In H1FY21, Zinclear slipped to 58% of product revenue due to Covid-related industry destocking and a one-time shift in revenue recognition, and gross margin surged to 75%, implying a blended cost of A$9.47/kg. Although some of the cost decrease in H1FY21 is due to a larger contribution from higher margin Alusion sales, margins also increased significantly in FY20 when the sales split was roughly unchanged. Ongoing unit cost reduction efforts during this time included diversification of precursor supply, a new production facility in Brisbane, upgraded production equipment, rooftop solar and storage battery installation, an upgraded electrical system, and the addition of a lab to bring required quality testing in-house.
| Period | Zinclear/Alusion | Product Revenue | Product GM% | Cost per kg |
| FY2018 | 82%/18% | A$6.58m | 63% | A$14.01 |
| FY2019 | 90%/10% | A$12.26m | 52% | A$18.15 |
| FY2020 | 88%/12% | A$17.97m | 61% | A$14.76 |
| H1 FY2021 | 58%/42% | A$3.43m | 75% | A$9.47 |
Nanomox calculates that their new method “uses 97 per cent less energy than the furnace method, and could reduce the cost per kilo from more than €30 (A$46.86) to less than €10 (A$15.62).” If this information is accurate, it means that the competition’s cost of production is higher than ANO’s sales price, and that ANO’s cost of production has already fallen well below Nanomox’s initial long-term target. While we already knew that ANO was the lowest priced zinc oxide in the market, this demonstrates just how unlikely it is that we will see a price war anytime soon. As two-thirds of the competition’s cost of production is linked to the cost of energy needed for extremely high temperatures, and that energy can likely only be supplied by combustible gases, the competition face structurally high costs that cannot be improved without a radical change in their chemical process. It may not be possible for this radical change to come from within; the more likely course of action could be to secure IP for a new process through the acquisition of a company like Nanomox.
If Nanomox determines that maintaining independence offers them the best path to unlocking the full potential of their novel OIS technology, then I suspect they would have a long road ahead to commercialization. It remains to be seen whether the zinc oxide nanoparticles they have produced in a lab setting are optimal for sunscreen or cosmetic applications, which require high transparency, broad spectrum UV absorbance, and dispersibility. It seems Nanomox are roughly where ANO was in 1997, when the company was first formed to develop MCP technology after successful trials at the University of Western Australia. It took ANO another 5 years to launch Zinclear after a partnership with Samsung Corning to refine the technology, and another fifteen years after that to turn a profit. It may take a similar period of time for Nanomox to refine their process through trial and error and achieve consistent scale production of particles with commercial applications, and currently they are still in the phase of looking for an industrial partner.
As ANO shareholders are well aware, the talents required to invent a breakthrough technology may not translate into the ability to scale it into a profitable business. For those just catching up, I covered the history of the Company’s turnaround led by current management here. Prior to the management change, sales stagnated and gross margins averaged about 20%:
Despite a lull in sales due to the previously mentioned industry-wide inventory destocking, management has continued to focus on improving the production cost, quality, and availability of Zinclear powders, dispersions, and concentrates in anticipation of a market recovery. Specifically, the Company has “established stockpiles in a central US logistics facility” to service its major manufacturing customers, expanded capacity and lowered the production cost of its dispersions by upgrading its high-speed mixing equipment, and received TGA approval for a range of vegan/organic dispersions and concentrates, an important step toward management’s goal of making a cost-efficient mineral alternative to chemical sunscreens widely available.
The takeaway here is that while it should not be unexpected that new methods of synthesizing zinc oxide will surface or that competitors will find ways to lower their cost of production, it will be very difficult to close such a wide gap with a leader that is also rapidly lowering their own cost of production. Vaporization techniques require structurally high energy costs, and new techniques will face many hurdles to reach commercialization at scale. To be clear, I’m optimistic that Nanomox will find commercial applications for its OIS technology and wish them the best in their endeavors to make the chemical industry more sustainable. However, I think from the standpoint of an ANO shareholder, I am not too concerned about other zinc oxide competitors and more focused on the opportunity to take market share from chemical sunscreens. The likelihood of a cheaper or more sustainable method than solar-powered MCP emerging is very low. At scale, the cost of production should trend toward the cost of raw materials, and ANO should continue to generate high margins even at lower prices as they increasingly move downstream into concentrates.
The other takeaway is that Alusion deserves more attention from investors going forward. Given its strong revenue growth through a weak economic environment, an even more attractive margin profile and competitive position than Zinclear, and the potential for the unique material to unlock some very large addressable markets, Alusion could have a bigger impact on ANO’s future profits than you might expect. I will attempt to quantify the Alusion opportunity in a future post, so keep an eye out for that. As always, thanks for reading!
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