CCF - Chase Corporation: A Cash Flow Powerhouse Worth Considering

2023-05-27 03:15:07 ET

Summary

• Chase Corporation reported robust revenues, earnings, and free cash flows, despite the challenging economic environment.
• The acquisition of NuCera Solutions played a significant role in the company's growth, but there were also signs of improvement in market conditions.
• The company's consistent generation of robust levels of free cash flows will likely enable it to further reduce its debt, thereby strengthening its financial position.

Chase Corporation ( CCF ) often remains tucked away as a hidden jewel in the corporate landscape. As I've noted before , it's a well-oiled profit and cash-flow machine, and this was also evident from the latest quarterly results. Moving forward, I expect Chase Corporation to deliver not just profits, but free cash flows that exceed my initial expectations. Such an influx of cash in the upcoming quarters won't just aid in shaving off recently accrued debt, but could also cast light on the company's future trajectory.

As a global provider of adhesives, sealants, and more, Chase Corporation operates manufacturing plants in the U.S., Europe, and Asia. While the company has spread its wings internationally, the lion's share of its earnings and revenue continues to pour in from the US. Last month, the financial figures for the three months ending in February were announced. The numbers aligned with my forecasts, barring an unexpected yet favorable development.

Earnings Commentary

Time for a quick earnings overview. Chase Corporation unveiled an impressive 27.5% upswing in revenues, which capped at $94.3 million. The gross margins held their ground at 36.8%, pretty much in line with the preceding year. The adjusted EBITDA jumped 31.4% to $22 million. This significant uptick in growth was set in motion largely by a major acquisition.

The company shelled out $250 million to bring NuCera Solutions under its umbrella-the largest acquisition in its history-finalized last September. NuCera, now a part of the Adhesives, Sealants, and Additives segment, drove 85% of the revenue surge. The rest of the boost was provided by price augmentations.

However, net income took a minor hit, slipping from $0.96 per share the previous year to $0.89 per share in the last quarter, largely due to the amortization expense connected with the acquisition. The adjusted net income remained undeterred at $0.98 per share, despite the soaring interest expenses and D&A charges in the wake of the acquisition. A bright spot was the company's free cash flows, reaching $10 million-a remarkable leap from the $1.6 million reported for the same quarter last year.

Taking a deeper dive into the numbers, it becomes evident that NuCera's acquisition, alongside price increases, drove Chase's growth. This sequence of events led to a whopping 53% boost in quarterly revenues within the Adhesives, Sealants and Additives segment, amounting to nearly $48.7 million.

Encouragingly, there were subtle signs of a rebound in demand, a positive development in this economic climate. In the Industrial Tapes segment, where the acquisition's impact was less pronounced, revenues saw a 15% hike to $36.9 million, largely thanks to a surge in demand for cable materials and specialty products in North America. Although the overall benefit of this demand surge was a modest $4.5 million-barely causing a ripple in the overall revenue pond, especially when juxtaposed with the weakness in other areas-it's a big step in the right direction nonetheless.

Delving further into the dynamics at play, Chase Corporation faced a ripple effect from the inventory reduction activities initiated by some of its clients. This led to a downward pull on the company's revenues, particularly impacting its smallest segment - Corrosion Protection and Waterproofing. This segment was the only one to witness an annual revenue decline, reporting a 3% dip to $8.56 million, predominantly attributable to the destocking activity.

However, it's not all gloom and doom. The destocking maneuver was a response to an improvement in supply chain conditions, and while this has previously been a thorn in the company's side, it could transition into a favorable wind pushing the company forward.

Looking Ahead

Chase Corporation's management talked about the "stabilization of the macro-economic environment". This stability was evident in the company's quarterly results. Despite the company's growth being predominantly fueled by the acquisition, a few positive strokes in the picture included the easing of supply chain issues that have been a persistent burden on the company's performance. A standout positive development, in my view, was the tremendous upswing in the free cash flows, a trend which may continue in the forthcoming quarters.

Remember, Chase Corporation has been steadily amassing inventories for over a year to ensure order fulfillment despite supply chain hiccups. This strategy has allowed the company to meet customer expectations, but it hasn't come without its downsides. The build-up of inventories led to an increase in capital expenditure, elevated inventory levels to unusually high degrees - which I perceived as a growing concern - and restrained the company's free cash flows.

At the close of Q1-FY2022, the company was sitting on $47 million worth of inventories, which ballooned to $63 million by the end of Q4-FY2022. Following the acquisition of NuCera, this figure surged to $86 million in Q1-FY2023. This equates to an alarming growth of more than 80% in just five quarters, without a matching rise in sales (revenues only rose by 37% in the same period). However, I think a turnaround has now started. With a stable economy and easing supply issues, the company began reducing inventory, boosting its free cash flows.

For Q2-FY2023, Chase Corporation reported a slight 2% contraction in inventory levels on a quarter-over-quarter basis, bringing it down to $84.3 million. It may not seem like a lot, but for a company accustomed to a sequential inventory growth of over 7% every quarter, I view this modest drop as a substantial stride towards progress. What's more, it establishes a promising groundwork for future developments.

With the majority of the supply chain snags having been addressed, I believe Chase Corporation is primed to further dwindle its inventory levels. Considering the company has already invested capital in this inventory, its eventual sale could cause a substantial jump in free cash flows going forward. The second quarter saw the company register a big rise in free cash flows, despite the seasonal softness engendered by the Chinese New Year that affected its Asian operations.

In the current and future periods, a resurgence in demand from Asia, which, coupled with the continued stability in the US and the ameliorating supply chain circumstances, should ensure Chase Corporation sustains robust levels of free cash flows, alongside potentially improved revenues and earnings.

In my opinion, the free cash flows will particularly empower Chase Corporation to fortify its financial position by repaying its debt. It's worth noting that the company resorted to borrowing last year to facilitate the purchase of NuCera. Just 12 months ago, the company was practically free of debt. However, the acquisition saw its debt swell to $180 million by August 2022.

The company then utilized its cash reserves to settle some of this debt in the first quarter, and leveraged the increase in free cash flows to retire additional debt in the second quarter. As a result, the second quarter ended with the company shouldering a long-term debt of $145 million, representing an almost 20% reduction within a span of just six months.

Moving forward, if Chase Corporation persistently registers healthy free cash flows, it's likely we will witness further debt reduction. Even at its current debt levels, the company's financial state appears reasonably sound, evidenced by its modest debt-to-equity ratio of a mere 38%. However, as it continues to decrease its debt load, this financial picture may only get rosier.

More importantly, Chase's debt reduction efforts should reassure investors of its growth potential, even in challenging climates. Historically, acquisitions have served as significant growth catalysts for Chase Corporation, and oftentimes, these acquisitions have been fueled by debt. The company has habitually utilized free cash flows to settle this debt.

However, I previously voiced concern that amid a weak economic environment with high interest rates, the company might find it difficult to continue this modus operandi. Yet, we now witness Chase Corporation continuing along this course. Granted, it benefits from its ongoing efforts to reduce its inventory levels, but it's worth noting that the company has generated free cash flows in preceding quarters too when it was still investing capital to amass inventories. For instance, in the last three quarters, it reported free cash flows of $4.7 million ( 1QFY23 ), $13.7 million ( 4QFY22 ), and $13 million ( 3QFY22 ).

This should provide investors with an assured sense of the company's prowess in generating free cash flows, and its capacity to allocate this surplus cash to service debt. The business environment may be challenging, but it's not sufficiently severe to significantly hamper Chase Corporation's strategy of leveraging debt to finance acquisitions for inorganic growth and subsequently generating free cash flows for debt repayment. If Chase Corporation continues to report free cash flows in the future, it will further affirm my perspective.

Takeaway

Chase Corporation has had an impressive run this year, with its shares climbing by 38% year-to-date, easily outpacing the S&P-500's modest 8.4% rise in the same period. As we look ahead, I anticipate the stock's continued success driven by revenue growth, robust earnings, significantly heightened free cash flows, and the ongoing reduction of debt. However, its shares currently seem a bit pricey, trading at 28x ttm earnings. Therefore, I'd advise investors to monitor CCF stock vigilantly and consider buying on weakness.

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