KOP - Koppers Holdings: Beware Of Cyclical Downturn

Summary

• Currently, Koppers Holdings has been trading for about $661 million, whereas it has produced about $85 million in the last year.
• Recently improved sales is attributed to higher average selling prices.
• Buying the stock at this valuation may not provide a margin of safety.

Introduction

Koppers Holdings ( KOP ) is a leading global provider of treated wood products, wood preservation chemicals, and carbon compounds. With the leading market position, the company operates through three major segments, Railroad and Utility Products and Services, Performance Chemicals, and Carbon Materials and Chemicals.

Railroad and Utility Products and Services

The segment primarily serves the North American railroad market with its 18 wood-treating plants and one rail joint bar manufacturing facility. The company is the largest supplier of railroad crossties to the class I railroads in North America, where it has a significant market share. A vertically integrated business model where the company can internally source creosote provides a significant competitive advantage. As the need to replace old crossties is increasing, the company can have considerable demand for its products in the upcoming years.

Performance chemical

With its copper manufacturing facility, the company provides various copper-related chemical products to lumbar treating companies in North America.

Carbon materials and Chemicals

The segment manufactures carbon-related products such as creosote, carbon pitch, and carbon black feedstock through its coal tar distillation facilities and carbon material terminal.

Although the company has a leading market position along with a vertically integrated business model, historically, operating performance has been extremely volatile, which shows that the business is prone to industry-wide demand and supply imbalance. Any reduction in demand might hamper the profit margins for a very long duration.

Due to its volatile operating performance, the stock price has seen significant fluctuations; After reaching a multi-year low of $8.38 per share in 2020, the stock has soured about 277%, reaching $31.6 per share. As per its last ten years range, the stock is near its top price.

Koppers has been producing significant returns in the last few quarters; it seems that the company is in its cyclical uptrend, and the valuation seems considerably higher. I believe it is better to avoid a cyclical stock at its high valuation.

Historical performance

From the last ten years, revenue has remained at nearly the same level. The company has seen slight fluctuations in net sales over the period, but it has managed to keep revenue above $1.6 million in the last three years. Although the revenue seems stable, net profits have fluctuated significantly from a significant loss of over $72 million in 2015 (attributed to high impairment charges), and it has reached $85 million by 2021. As the pricing for its products has been improving over the last three years, the company has produced substantially strong profits.

Also, over the years, Koppers has managed its debt levels at an adequate level. As a result of subdued business performance, reserves had become negative during 2015 , but due to the strong performance in recent years, it has grown to significant levels.

Despite substantial fluctuations in the net profits, cash flow from operations has remained strong and has produced huge cash flows for the business.

Strength in the business model

The debt levels have been managed at moderate levels, which provides significant stability to the business. The company has been a leader in its all three segments; also, it has a vertically integrated business model, which provides a significant competitive edge to Koppers.

Also, with its strong business model, the company has been expanding its market share , which can improve the operating results in the upcoming years. Furthermore, the recently acquired Gross & Janes Co. can help the company to strengthen its position.

Risk factors

Historically demand for wood crossties, carbon pitch, and other railroad products have been significantly cyclical; as a result, the company's operating performance has seen substantial fluctuations. Such huge fluctuations in the demand and pricing of these products might lead to subdued margins; in such case, the stock price might see a substantial correction.

Furthermore, the valuation of the company seems fair, and owning the stock at this price might not produce attractive returns to the shareholder.

Also, about 38% of the total revenue comes from the top ten customers; such a high customer concentration might put the business model at considerable risk; during adverse economic conditions, the company might face significant pricing pressure from its customer, which can affect the company's financial condition.

Recent development

During the last nine-month period, the company has produced substantially strong revenue, which increased from $1.27 billion in the same quarter last year to about $1.49 billion. But as a result of the higher cost of sales and increased tax provision, the net profit has dropped to $49.6 million. In the recent quarter, Koppers has achieved higher profits, and the business performance seems to be improving.

The sales increase was largely related to pricing increases across multiple markets, particularly crossties and utility poles, and activity increases in our railroad bridge services business.

Recent quarterly report

Recently improved sales are primarily attributed to higher average selling prices for its products; Therefore, the investor must consider that such a performance might not sustain for a longer duration.

As a result of stronger performance in all three segments, management has forecasted that the FY 2022 sales will reach nearly $2 billion.

Currently, the company has been trading for about $661 million, whereas it has produced about $85 million in the last year, which gives it a valuation of nearly eight times its 2021 earnings. Investors must consider that such a performance is attributed to industrywide strong demand and pricing and if the demand slumps, the company might face significant pressure on margins. I believe the current valuation seems fair, and buying the stock at this level may not provide the margin of safety; therefore, I assign a sell rating to the stock.

For further details see: