BOOM - DMC Global Shows Clear Signs Of Improvement

2023-05-15 14:26:32 ET

Summary

• DMC Global's DynaStage perforating systems continue to evolve and get close to commercialization.
• NobelClad recorded a steep rise in backlog in Q1.
• Arcadia segment gains efficiency, but the recessionary fears can pull down demand.
• Relative valuation multiples look reasonable with low leverage and a positive free cash flow.

BOOM's Opportunities And A Few Concerns

I discussed DMC Global's ( BOOM ) strategies and performance in my previous article . In 2023, DynaStage perforating systems remain at its center stage of growth. It has recently developed two next-generation DynaStage systems and plans to commercialize them in 2023. Due to the current recessionary fear, the company will shun the Arcadia sales growth to maintain its market share and expand its operating margin. Its NobelClad segment margin, however, can be adversely affected by a less favorable project mix.

The company's cash flows turned positive in Q1 and will likely gain further momentum in 2H 2023. It plans to deleverage further from its free cash flow growth. The stock price declined by 13% over the past month, which makes way for a rebound. The stock is reasonably valued versus its peers. Investors would do well to "buy" the stock, expecting higher returns in the medium-to-long term.

The Critical Drivers

The top drivers for BOOM are architectural building products, business integration, and capacity expansion initiatives. Also, its flagship DynaStage perforating systems in the energy business did well, while its composite metals business NobelClad recorded a steep rise in backlog in Q1 (8% up from Q4). The company looks to improve efficiency in its Arcadia segment, which deals in the high-end residential market in the industrial construction, education, medical, and hospitality sectors. In particular, it expects to increase painting capacity in 2023, along with stable growth in the core petrochemical and downstream energy markets.

Strategy And Growth Factors

In the DynaEnergetics segment, demand for completion programs in its North American onshore market was high. The consecutive quarter-over-quarter growth for the DynaStage perforating systems reflects the company's manufacturing strength in Germany and Texas. International demand at DynaStage accounted for ~13% of the Q1 sales. The product is favorable for margin expansion due to an efficient manufacturing process and streamlined product designed for specialized downhaul applications.

The company continues to invest in further product development. As a result, it has developed two next-generation DynaStage systems and plans to commercialize these products later in 2023. However, investors should also be aware of two patent cases concerning DynaStage and their litigation costs.

What's The Outlook?

Based on the expectations and critical drivers forming in Q1, BOOM's management expects its Q2 revenues to remain nearly unchanged (at the guidance mid-point). Segment-wise, Arcadia can see a 5% revenue fall due primarily to flat activity in North America.

However, in Q2, the company will focus more on maintaining its market share and expanding its operating margin. In NobleClad, on the other hand, the Q2 revenues could increase by 5%. The company's gross margin is also expected to increase to 29%-30% compared with 28% in Q1. While the margin will likely grow in Arcadia and DynaEnergetics, NobelClad's margins might be adversely affected by a less favorable project mix.

How Did The Segments Perform In Q1?

Higher volumes benefited the Arcadia segment, where revenue increased by 8% in Q1 2023 compared to Q4 2022. The Western and Southwestern United States saw strong demand in many commercial construction markets. In the NobelClad segment, sales shrank by 4.7% in Q1. Despite lower sales, its book-to-bill ratio of 1.2x (more than one) should improve its sales performance in Q2. In the DynaEnergetics segment, revenues increased by 5.7% quarter-over-quarter. Higher sales of DynaStage perforating systems in the core North American onshore market and the introduction of premium perforating systems caused sales to grow in Q1.

BOOM's gross margin expanded by nearly 250 basis points in Q1 compared to Q4, while adjusted EBITDA margin expanded by 40 basis points. Recovery in the Arcadia margin and steady margin in the other segments caused the operating margin to improve in Q1.

Cash Flows And Balance Sheet

In Q1 2023, BOOM's cash flow from operations, led by higher revenues, turned positive compared to a negative CFO a year ago. Free cash flow also turned positive in Q1 2023. Investors may note that free cash flow conversion in Q1 typically stays low, which implies it will likely improve in the coming quarters in 2023. The company used its FCF for principal payments on its long-term debt associated with the Arcadia acquisition.

BOOM's net debt was $107 million as of March 31, 2023. Its leverage (debt-to-equity) of 0.33x is much lower than many of its peers, and it has a total liquidity of $70 million (cash plus revolving credit facility). So, its financial risks are limited in my view.

What Does The Relative Valuation Imply?

BOOM's EV/EBITDA multiple (8.1x) contraction to the forward EV/EBITDA (6.8x) 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 (11.2x). So, the stock is reasonably valued versus its peers at the current level.

Target Price And Analyst Rating

Two analysts rated BOOM a "Buy" (includes "Strong Buy") over the past three months. One rated it a "Hold," and none rated it a "Sell." The consensus target price is $34, which implies a ~96% upside at the current price.

Why Do I Change My Rating On BOOM?

I was cautiously optimistic about DMC Global in my previous article. The market appeared at the cusp of rapidly accepting BOOM's integrated perforating gun systems. It also had the advantage of low leverage and a positive FCF. But it did face some headwinds from raw material inflation, which affected its gross margin. I wrote :

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.

After Q1, many positives have come out for the company. The key drivers are the higher demand for painting materials from the high-end residential market and stable growth in the core petrochemical and downstream energy markets. The DynaStage perforating system sales accelerated, as expected. So, I change my position from a "Hold" to a "Buy."

What's My Take On BOOM?

In 2023, BOOM's Arcadia segment has made substantial efficiency gains in the high-end residential market in the industrial construction, education, medical, and hospitality sectors. The DynaStage perforating system sales grew in Q1, which reflects the company's manufacturing strength in Germany and Texas. Its NobelClad segment margin, however, can be adversely affected by a less favorable project mix.

However, adverse outcomes on the two patent cases concerning DynaStage's perforating system can derail its outlook. Its leverage (debt-to-equity) is already lower than many of its peers, while it plans to deleverage further from its free cash flow growth. Despite the positive drivers, the stock price underperformed the VanEck Vectors Oil Services ETF ( OIH ) in the past year due mainly to the recessionary pullback. Given the relative valuation multiple, I expect returns from the stock to improve in the medium-to-long term.

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