KWR - Quaker Chemical: A Mixed Bag

2023-07-14 08:39:42 ET

Summary

• Quaker Chemical sees sales and earnings improving on the back of strong pricing, with volumes trending negative.
• The company is not yet living fully up to expectations, as a sluggish performance has been going on for a while.
• With a current multiple being quite demanding, I conclude to have a neutral stance.

In January, I concluded that the real chemistry was missing with regard to shares of Quaker Chemical (KWR) . This came after the company has seen a tough 2022, including poor working capital conversion.

With valuation multiples and leverage ratios being substantial and a bit demanding, I saw few triggers in sight to drive outperformance in the shares. This is confirmed by a flattish performance in the first half of the year, amidst modest sales and earnings advancements, although still accompanied by significant pressure on volumes.

A Base

Quaker Chemical's investment thesis has been determined by the 2019 deal for Houghton, as the timing of the deal was rather unfortunate, with the pandemic breaking out soon thereafter. A recovery was seen at the start of 2021, although supply chain issues and emerging inflation hurt the recovery and overall results thereafter.

The deal with Houghton created a $1.6 billion business which was generating a quarter of a billion in EBITDA, a number set to increase to $300 million upon realization of deal-related synergies. That was needed in the attempt to create a global leader in industrial process fluids, creating a more diversified industrial empire related to metalworking, primary metals and global specialties. The company is competing against the likes of Fuchs, Henkel and Castrol in these markets, among some other competitors.

The merged company would operate with a 3.4 times leverage number. The $170 price tag at the time of the deal announcement was actually not all that different from prevailing levels at which shares trade.

Following a tough 2022, sales fell to $1.42 billion, with EBITDA falling to $222 million, although leverage ratios improved to 3.2 times, with adjusted earnings reported at $4.78 per share. Following the guidance for a strong recovery in 2021, shares rose to a high of $300 in spring of that year as investors were upbeat on the earnings power of the combination.

In the end sales grew by 24% to $1.76 billion for the year 2021, although this was driven by inflation with volumes growth actually being negative. Full year earnings improved in a huge fashion to $6.85 per share, albeit that fourth quarter earnings came in at just $1.29 per share.

EBITDA rose to $274 million, reducing leverage ratios to 2.6 times based on a net debt load of $728 million. Supply chain issues, inflation, and a strong dollar made that 2022 sales rose, but margins took a beating. Based on the third quarter results I pegged the revenue run rate at $1.9 billion, EBITDA around $250 million and earnings up around $6 per share, all while net debt was up to $813 million.

With shares trading a few dollars below the $200 mark, the resulting earnings multiple was very demanding, although this was based on suppressed earnings in 2022, as there was room for improved earnings performance. That said, I failed to see a compelling risk-reward given the demanding valuation from the get-go.

Trading Stagnant

Since the start of the year, shares of largely traded around the $200 mark with relative modest volatility, as the flattish returns and share price performance were seen in the light of few corporate events taking place.

In February, Quaker posted a 10% increase in full year sales to $1.94 billion, with adjusted earnings falling by a dollar to $5.87 per share and EBITDA falling to $257 million. The company posted a big GAAP loss in the first quarter, due to a $93 million impairment charge, although that adjusted earnings improved ten cents (on an annual basis) to $1.39 per share. While the company did not provide a guidance for 2023, it guided for margin improvements on the back of pricing and cost actions being taken.

In May, Quaker posted a 5% increase in first quarter sales to $500 million, but margins improved more meaningfully despite a poor composition of sales growth with prices up 19%, volumes down 11% and currencies hurting sales growth by 3%. Adjusted EBITDA improved by $19 million to $79 million, with adjusted earnings of $1.89 per share improving by nearly half a dollar. Net debt ticked down to $753 million, for a 2.7 times leverage ratio, all while no formal guidance was issued for the year.

Based on the improved earnings power and run rate around $7.50 per share, earnings power was improving, but the resulting earnings multiple of around 27 times remained demanding. It appears that there might be more room for improved EBITDA and earnings performance, but likely this will be limited to around $10 per share, as I furthermore not the long-term performance from Quaker has been a bit underwhelming.

Still Cautious

Despite a promising start to 2023, at least in terms of margins, but not volumes, I fail to see imminent appeal. Even if we look at better margins, and thus earnings, valuations remain demanding as the underlying strength (read volume declines) are causes for concerns.

Given all this, I am cautious, and I do not see imminent appeal, with no reason to alter a neutral stance here. While I believe that the company could improve its performance, that might not be enough to create compelling upside.

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