BOOM - DMC Global Is Poised To Hold Its Ground

Summary

• DMC Global's gross margin took a downturn in Q3 as the effect of previous price raises wear off.
• The impact of inflation on raw materials would remain a worry for BOOM.
• The changing nature of the perforating gun market would be beneficial for the company's integrated product system.
• With low leverage and a positive free cash flow, relative valuation multiples look reasonable.

Mixed Signal For Boom

I explained DMC Global's ( BOOM ) strategies in detail in my previous article here . By the end of Q3, BOOM’s price hikes, initiated in early 2022, subsided. So, the impact of inflation on raw materials became a worry. With less project mix and the effect of higher-priced aluminum inventory, the company's gross margin can remain under pressure in Q4. Plus, the Arcadia and NobelClad segments' topline can decline in Q4.

On the other hand, BOOM is set to drive home the benefits of the integrated perforating gun systems transitioning from a component-supplied business to a product supply and service industry. Its cash flows turned positive in 9M 2022. The stock is reasonably valued versus its peers. With a steady balance sheet, investors may "hold" the stock. I expect modest returns in the short term.

Explaining The Arcadia Segment Drivers

Continuing with the strategic approach in Arcadia, as I discussed in my previous article, DMC Global has added the capability for high-end homes, including mid-rise buildings in the Western and Southwestern US, through the acquisition of Arcadia. Its new service centers in Dallas and Houston are expected to fuel strong long-term growth. Demand for Arcadia's services has been high in hotels, educational facilities, and casinos. It also led to high-priced aluminum inventory, which pressured its gross margin in Q3. By Q4, the segment gross margins should return to normalized levels (low-to-mid 30% range).

According to the FRED economic data, the new privately-owned housing units decreased by 6% between September and December and 22% in the past year. The concern over the recession and much higher interest rates have started to affect the low and high end of the residential market, which can adversely affect DMC Global.

Strategy And Pricing Trend

The industry is moving towards an integrated perforating gun system. The market is transforming from a component-supplied business to a product supply and service industry. BOOM's management believes its market share is increasing because it undertakes full responsibility for its performance, timely delivery, and safety aspects of the perforating system.

In 2H 2022, the other noticeable characteristic of DMC Global's operations was its ability to move the slow-moving inventory, although it came at a cost. It had to lower its price, which adversely affected its gross margin. In Q3, the company's gross margin contracted. Also, its revenue concentration increased, slowing any profitability growth. In 2023, the company expects pricing acceleration, which can free up its margin.

The Industry Indicators

The energy indicators changed little in Q4. Since Q3, the crude oil price has moved sideways. The US rig count went up by 2% in Q4 but declined slightly in January. The frac spread count (11% fall) underperformed the US rig count since Q3. Similarly, the completed well count growth was negligible in this period.

Q4 2022 Guidance

Over the medium term, NobelClad can benefit from several large industrial projects that are moving to the award phase. The company's management expects the top line to decrease by 7% in Q4. The Arcadia segment revenues can go down by 10% (at the guidance midpoint). DynaEnergetics segment revenues are expected to decrease modestly (by 1%). The NobelClad segment's topline can decline the most in Q4 (by 12%). The company gross margin can also shrink by 100 basis points (at the guidance mid-point) due to the unfavorable project mix at NobelClad and the effect of Arcadia's higher-priced aluminum inventory.

How Did The Segments Perform In Q3?

Robust activity in the well-completion industry across the world benefited the DynaEnergetics segment, where revenue increased by 4.2% in Q3 2022 compared to Q2. North American E&P companies have adopted BOOM's fully integrated DS perforating systems due to its superior safety features and efficiency. The factory-assembled DS perforating system sales were a landmark in 2022 – the highest since its launch in 2015. In NobelClad (the composite metals business), sales grew by 7.1% in Q3. The segment order backlog increased for the past three quarters, albeit modestly, brightening the near-to-medium-term sales growth outlook.

Despite the topline growth, BOOM'S gross margin contracted by nearly 200 basis points in Q3 compared to Q2. A dip in gross margin at Arcadia following the volatility in aluminum prices offset the positive effects of higher volume on fixed costs at DynaEnergetics.

Cash Flows And Balance Sheet

In 9M 2022, BOOM's cash flow from operations turned significantly positive compared to a negative CFO a year ago, led by much higher revenues during this period. Free cash flow also turned positive in 9M 2022. However, higher inventory levels at DynaEnergetics and higher input prices at Arcadia offset cash flow growth.

BOOM had total debt of $136 million as of September 30, 2022. Its leverage (debt-to-equity) of 0.38x is much lower than many of its peers, and it has an undrawn and available $50 million revolving credit facility. So, its financial risks are limited.

What Does The Relative Valuation Imply?

BOOM's EV/EBITDA multiple (13.3x) contraction to the forward EV/EBITDA (11.4x) is less steep than peers' (CLB, HAL, and OIS), implying a less sharp EBITDA growth, which typically results in a lower EV/EBITDA multiple. The stock's current multiple is lower than its peers (16.3x). So, the stock appears to be reasonably valued versus its peers at the current level.

Target Price And Analyst Rating

During the past 90- days, two sell-street analysts rated BOOM a "Buy" (includes "Strong Buy"). One rated it a "Hold," and none rated it a "Sell." The consensus target price is $33, which has a ~31% upside at the current price.

Why Do I Maintain My Rating On BOOM?

In my previous article, I discussed how, with a couple of price hikes, DMC Global's gross margin made a considerable stride. Also, the newly acquired Arcadia segment brought in the civic facilities, education, and healthcare end markets, which are typically countercyclical. I wrote :

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.

After Q3, DMC's tryst with the slow-moving inventory continued, which came at a cost. It had to lower its price, which adversely affected its gross margin. Its energy service and integrated perforating gun business are on better footing, but Arcadia is likely to face headwinds from a demand recession in the housing market. The stock is still reasonably valued. So, I maintain my "hold" rating.

What's The Take On BOOM?

The industry indicators remained flat in Q4, while the economic indicators point to a global slowdown. The Arcadia and NobelClad segments' topline can decline in Q4. Similarly, the company's gross margin can contract due to unfavorable project mix and the effect of higher-priced aluminum inventory. So, the stock price significantly underperformed the VanEck Vectors Oil Services ETF ( OIH ) in the past year.

Despite higher working capital requirements, cash flow from operations turned significantly positive in 9M 2022 compared to a negative CFO a year ago. Its leverage is much lower than many of its peers. As induced by various opposing drivers, the stock can remain steady at the current level in the near term.

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