BCPC - Balchem: A Mixed Quarter

2023-05-01 12:08:09 ET

Summary

• It was a mixed quarter for BCPC in Q1 2023, as Balchem's better-than-expected earnings weren't driven by revenue growth acceleration.
• Balchem's near-term inorganic growth prospects might be less exciting, as the company places a stronger emphasis on deleveraging.
• I retain my Hold rating for BCPC, after evaluating Balchem's Q1 2023 results and its capital allocation priorities.

Elevator Pitch

I have a Hold investment rating awarded to Balchem Corporation's ( BCPC ) shares.

I wrote about Balchem's inorganic growth strategy and expectations of rising operating and financial expenses in my earlier update for BCPC, published on September 12, 2022. My current article assesses Balchem's most recent quarterly financial performance and its capital allocation approach.

My view is that BCPC's outlook is mixed. Balchem's top-line growth could remain subdued, while there is a good chance of further margin improvement for the company. Separately, Balchem will generate interest cost savings from debt repayment, but this will divert capital away from potential acquisitions. As such, I have decided to leave my Hold rating for BCPC unchanged.

Q1 2023 Financial Results Were Mixed

On Friday, April 28, 2023, before the market opened, Balchem announced the company's financial results for the first quarter of the current fiscal year. Although BCPC achieved an earnings beat for Q1 2023, the company's revenue fell short of the analysts' expectations, and it suffered from significant revenue growth deceleration in the recent quarter.

Balchem's top line increased slightly from $228.9 million in the first quarter of last year to $232.5 million for the first quarter of the current year. This implied that the company's revenue growth has slowed from +23.3% for Q1 2022 and +9.1% for Q4 2022 to just +1.6% in Q1 2023. BCPC's first quarter actual sales also came in -0.4% lower as compared to the sell-side consensus projection of $233.5 million .

At the company's Q1 2023 earnings call on April 28, 2023, BCPC admitted that the company's revenue performance in the recent quarter was hurt by "destocking" with "customers adjusting their inventory levels down" as "the demand outlook became more uncertain." I predict that Balchem's revenue growth will remain sluggish at the single-digit percentage level (on a YoY basis) for the next two to three quarters at the very least, considering management commentary on client demand.

On the flip side, BCPC's Q1 2023 non-GAAP normalized earnings per share or EPS of $0.94 surpassed the market's consensus bottom line estimate of $0.82 by a substantial + 14.6% , even though its EPS had contracted by -8.7% YoY. In that respect, Balchem's above-expectations first-quarter bottom line wasn't a high-quality earnings beat, as the company's revenue for the most recent quarter wasn't as good as what the sell-side would have expected.

Unlike its revenue growth prospects, Balchem's profitability outlook is pretty encouraging. BCPC's non-GAAP adjusted EBITDA margin improved by +3.1 percentage points QoQ from 21.0% in Q4 2022 to 24.1% for Q1 2023. Moving forward, BCPC highlighted at its Q1 2023 earnings briefing that it sees its normalized EBITDA margin recovering further to 25% and above in the current fiscal year thanks to "price increases" and a "stabilization" of expenses. It is noteworthy that Balchem had been able to achieve annual EBITDA margins in excess of 24.9% for five consecutive years between FY 2015 and FY 2019 prior to COVID-19. With supply chain pressures abating and prices of commodities in general declining, it does seem realistic that Balchem's EBITDA margin returns to pre-pandemic levels.

Relatively High Financial Leverage Might Limit The Capacity For Future Acquisitions

BCPC's net debt-to-EBITDA or financial leverage ratio was 1.7 times as of March 31, 2023, as indicated in the company's Q1 2023 results presentation slides .

On the surface, Balchem's financial leverage ratio appears to be reasonably comfortable on an absolute basis, but BCPC's current net debt-to-EBITDA metric is actually very high as compared to the company's historical leverage numbers. As highlighted in its recent quarterly results presentation, Balchem's net leverage ratio was only 0.5 times at the end of 2020, and the company's net debt-to-EBITDA metric dropped to below 0.1 times as of December 31, 2021. Between 2010 and 2013, BCPC was in a net cash position. In fact, Balchem's peak financial leverage ratio was just 2.3 times at the end of 2014.

It is clear that the company is pretty conservative when it comes to financial leverage. As such, it isn't a surprise that Balchem emphasized at its Q1 2023 results call that its "preference right now is to invest in our organic growth and pay down a little debt" and guided for leverage "coming down as the year progresses."

Separately, Balchem revealed at the prior Q4 2022 earnings call in late-February 2023 that its effective cost of debt was a meaningful 6%. Also, BCPC's interest expenses rose approximately 20% in Q1 2023, with the rising cost of debt being a key contributing factor. Therefore, it makes sense for BCPC to pay down a larger proportion of its debt.

While it is a good thing that BCPC deleverages and strengthens its balance sheet, this will inevitably come at the expense of slower growth. Balchem completed eight M&A transactions between 2016 and 2022, and this was a major factor driving BCPC's impressive +10% revenue CAGR (source: S&P Capital IQ ) for this time period. If BCPC's pace of acquisition slows, the company's future revenue growth rate will naturally be lower as a result.

Closing Thoughts

I continue to have a Neutral view of Balchem's stock, following an analysis of BCPC's capital allocation strategy and its recent Q1 2023 financial performance. This explains why I have chosen to maintain a Hold investment rating for BCPC.

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