CSTE - Caesarstone: Waiting For Lower Prices And A Return To Profitability

2023-11-13 11:20:24 ET

Summary

• Caesarstone's earnings continue in negative territory, with six consecutive bottom-line misses since Q2 of fiscal 2022.
• The company plans to launch innovative collections in the upcoming months to improve customer interest.
• Despite low profitability, Caesarstone's low stock price and strong balance sheet make it attractive to value investors.

Intro

We wrote about Caesarstone Ltd. (CSTE) back in late July this year when we cited how the sale of the company's flagship manufacturing plant in Israel ( Sdot Yam ) was a clear indication that customer demand was on the wane. To add insult to injury, the ongoing war in Israel continues to take a chunk out of the company's earnings (5% at present) so it will be interesting to see if more layoffs are ahead for CSTE. Caesarstone due to very poor growth metrics in recent times has had to undergo a restructuring plan to remain alive. No signs of a turnaround however have yet to materialize as Caesarstone's recent Q3 earnings numbers illustrated yet a further earnings miss (Normalized EPS of -$0.20 per share) which now makes it six consecutive normalized EPS misses since Q2 of fiscal 2022.

The first part of the restructuring plan was to stop the bleeding (concerning cash being drained) from the company and the company has been having success in this endeavor. However, as we see below, the lion's share of Caesarstone's restructuring is indeed linked to taking costs out of the system which will work but only over the near term. In effect, what the market needs to see is a roadmap toward growth, especially in the US which is CSTE's biggest opportunity.

As a result, Caesarstone long-term chart looks abysmal with lower highs & lower lows having become the norm for some time now. However, deep-value investors will be watching CSTE for several reasons (primarily the balance sheet). Although the company's profitability & growth metrics are on the floor at present, the lower this stock goes, the more attractive it will become. The one caveat however is that the market (investors) will eventually need to see a roadmap to sustained growth for the company. That trend remains amiss in Caesarstone thus explaining the abysmal trend in the company's technicals to date.

Innovation Remains Key

Although rising interest rates have undoubtedly contributed to the dampening of demand for CSTE products over the past couple of years, management has to accept that its company's kitchen countertops' offerings (value/price breakdown) have not been able to 'register' with customers in a meaningful way . On this point, the company is expected to launch several innovative collections in the upcoming months so it will be interesting to see if R&D initiatives can bear fruit.

From an investor's standpoint, relaying a percentage of production to third-party manufacturers (to reduce costs) as well as investing heavily in R&D efforts (to improve quality) are areas where one would hope will be prioritized going forward. Costly 'Sales & Marketing' initiatives (which management is keen on ramping up in the US & other international markets) should be refrained from for the following reasons.

If Caesarstone's new collections can move the needle (due to a much better quality/value paradigm), then they will market themselves over time. For instance, even in the down markets, market leaders tend to gain a share from competitors because their offerings are more attractive to customers (quality/value breakdown). Caesarstone needs to work towards putting itself in a similar position.

Positive Earnings Need To Appear

Although Caesarstone continues to generate positive operating cash flow ($28+ million in Q3 alone), operating profit remains in the red highlighted by the -$1.98 million EBIT number for Q3. Inventory, working capital, gross margin, and SG&A costs are all trending in the right way sequentially to trim down the company and bring in cash but forward-looking earnings revisions continue to be dialed down. Suffice it to say, that the market continues to believe that CSTE cannot grow its sales going forward. This belief most likely means more losses in the share price will transpire at least over the near term.

However, the lower this stock goes, the more appealing CSTE will become. We state this because the company has ultra-low trailing book, sales & cash-flow multiples which are trading well below Caesarstone's historic averages as well as sector averages. Furthermore, CSTE reported debt to financial institutions of a mere $6.9 million at the end of Q3 is immaterial in the grand scheme of things when compared to its sizable shareholder equity of $360+ million.

Although CSTE's trailing cash-flow multiple of 2.60 may not be a clear reflection of the cash-flow statement (due to how the company has been getting smaller), the company's assets (strengthened by almost $40 million of treasury stock) & sales better highlight Casterstone's promise here. Investors need to understand however that CSTE's recent success with its cash-flow generation has a limited shelf life. Positive earnings (or a clear roadmap to the same) is the precursor needed to stop the technical pattern of lower lows in earnest.

Conclusion

To sum up, the best-case scenario here for value investors is that the stock keeps on making lower lows but gets ever closer to reporting positive bottom-line profitability. For every $1 invested currently, one can pick up $2.56 of the company's assets (which are primarily made up of current assets and net Property, Plant, and equipment). While this may look like a bargain, profitability remains amiss, so patience is required. Let's see what Q4 brings for the company. We look forward to continuing coverage.

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