OIH - DMC Global: Arcadia Adds To The Revenue Stability

• Following two price hikes in the past two quarters, DMC Global's gross margin made a considerable stride in Q1.
• Its newly added Arcadia segment has brought in the civic facilities, education, and healthcare end markets, which are typically countercyclical and have consistent demand.
• The NobelClad segment revenue can decline in Q2 following the recession fear.
• Although the leverage ratio is not high, the negative cashflow is a concern.

Strategic Moves To Counter Cash Flow Issues

The Arcadia acquisition will diversify DMC Global Inc.'s ( BOOM ) revenue base and bring elements related to the countercyclical industrial infrastructure markets in 2022. In Q2, I expect the topline and operating margin to improve following an increase in international sales and the pricing recovery in North America.

However, the specter of a recession following the interest rate hike and the early-Q2 housing market might pull the NobleCald segment down. The global supply chain bottlenecks are not over yet. Cash flows, too, turned negative in Q1. The stock is reasonably valued versus its peers. Despite that, the improved fundamentals can induce the stock to yield positive returns in the medium term. Investors would do well to hold the stock at this level.

The Arcadia Segment Drivers Explained

Through the Arcadia acquisition, DMC Global has added the capability for the high-end homes using Arcadia's engineering-built products for commercial buildings and residential real estate. During Q1, it implemented a healthy selling price in this new segment, offsetting the 20% increase in aluminum prices, which is Arcadia's primary input. Arcadia primarily caters to the mid-rise buildings in the Western and Southwestern U.S. It also provides the high-end residential real estate market with steel, aluminum, and wood products. The civic facilities, education, and healthcare markets are typically countercyclical and have consistent demand.

According to the FRED economic data, the new privately-owned housing units remained steady between January and April before decreasing by 7% in May 2022. As recession fear looms on the corner, rising interest rates affect the higher end of the residential market less than the other segments. So, a countercyclical industry can help steady the ship for DMC Global.

Strategic Approach And Pricing Outlook

You may read about BOOM's strategies and its integrated perforating gun systems in my previous article here . As the company performs in three distinctly different business categories, it has adopted a different method. For example, it has adopted a system approach versus a component approach in DynaEnergetics. Arcadia has a combination of other products and end markets. Also, Arcadia's market segments supplement NobelClad's industrial markets. The primary focus is to maximize gross margin from these market segments. Overall, the company's gross margin made a considerable stride in Q1, inflating by nearly 900 basis points due to increased volume at DynaEnergetics on the manufacturing overhead expenses.

In early Q2, BOOM implemented the second round of price hikes within the past six months in the DynaEnergetics segment. During 1, demand for DynaEnergetics products increased significantly and will likely remain so during the rest of 2022. So, higher-margin international sales and improved efficiencies will drive a gross margin expansion in Q2.

The Industry Indicators

The energy indicators have remained steady in Q2 so far. Since Q1, the crude oil price has gone up by 8%. The U.S. rig count went up by 12%. However, the completed well count growth in the key U.S. shales is moderate in this period. Per Primary Vision, the frac spread count (6% rise) underperformed the US rig count from Q1 to Q2.

Q2 2022 Guidance

DMC Global expects the top line to increase by 6% in Q2. Revenues in the Arcadia segment can go up by 3% (at the guidance midpoint), reflecting higher pricing, according to the company's estimates. DynaEnergetics segment revenues are expected to increase impressively (15% projected growth) following higher international sales and improved pricing in North America. The management expects the NobelClad segment's topline to decline by 4%.

How Did The Segments Perform In Q1?

Modest completion activity following sand shortages and supply chain constraints led to DynaEnergetics segment revenue falling by 3.5% in Q1 2022 compared to Q4 2021. Despite the early setback, there are sufficient signals in the market that demand for BOOM's fully integrated DS perforating systems is picking up because of its safety and fast turn-around time. The system helps reduce the cost of completing a well. The Q2 shipments in April were similar to the March level.

In Q2, bookings are healthy (1.02x), which brightens the medium-to-long term profit growth outlook. However, some of the gains mitigate higher material costs at DynaEnergetics and adverse changes in margin mix in international sales. In contrast, the NobelClad segment revenues increased by 3.3% in Q1.

Cash Flows And Balance Sheet

In Q1 2022, BOOM's cash flow from operations (or CFO) turned negative compared to a positive CFO a year ago. Although revenues increased significantly during this period, higher inventory levels and lead times for several key raw materials at DynaEnergetics and Arcadia caused the CFO to decline. Obviously, the free cash flow was negative in Q1.

BOOM had total debt of $144 million as of March 31, 2022. Its leverage (debt-to-equity) of 0.41x is much lower than many of its peers, and it has an undrawn and available $50 million revolving credit facility. So, the financial risks are limited despite the Arcadia acquisition.

Linear Regression Based Revenue Forecast

Based on a regression equation consisting of crude oil price, total rig count, and BOOM's revenues for the past seven years and eight quarters, I expect revenues to increase steadily in NTM 2023 and NTM 2024.

The linear regression model using the forecast revenues suggests its EBITDA will increase sharply in NTM 2023. The growth rate may decrease in NTM 2024 but will still be relatively healthy.

Relative Valuation And Target Price

Returns potential using the past average multiple (167% upside) is much higher than the returns potential using the forward EV/EBITDA multiple (9.0x) (19% downside). The Wall Street analysts also expect steep returns (105% upside) from the stock.

BOOM's EV/EBITDA multiple (54x) is significantly higher than peers' (GRC, HAL, and OIS) average of 13.2x. This justifies the forward EV-to-EBITDA multiple contraction versus the current EV/EBITDA. So, the stock is reasonably valued at the current price.

What's The Take On BOOM?

BOOM continues to implement higher pricing to mitigate the effect of inflation on raw materials. The typical energy industry indicators have stayed strong in Q2, thus strengthening the company's expectations of bolder revenue growth and operating margin expansion in 2022. The international markets, too, have proved margin-accretive for the company.

However, the early Q2 housing market indicators point to a weakness, which might pull the outlook down along with the recessionary fear. The global supply chain bottlenecks are not over yet. Revenues in the NobelClad segment can decline in Q2. With uncertainty surrounding the economy, the stock price significantly underperformed the VanEck Vectors Oil Services ETF ( OIH ) in the past year. Induced by the strong drivers, the stock has a positive bias at the current level.

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