KWR - Quaker Chemical: The Real Chemistry Is Still Missing

Summary

• Quaker Chemical Corporation saw a tough 2022, including poor working capital conversion.
• Valuation multiples and leverage remain significant, with few near-term triggers in sight.
• With Quaker Chemical shares holding up quite well, I am cautious at current valuations.

Shares of Quaker Chemical Corporation ( KWR ) have pretty much traded rangebound between $140 and $200 over the past year. Almost a year ago, I concluded that I was slowly developing some chemistry for the shares with KWR stock trading in the $180s at the time.

Tougher economic conditions and concerns on the economy meant that KWR shares hit a low of $130 later in the summer, but by now shares have recovered to the $195 mark again, marking very modest returns over the past year, even after a recovery from the summer lows.

A Recap

Quaker Chemical Corporation's investment thesis has been dominated by the 2019 deal for Houghton, as the timing of that deal just ahead of the outbreak of the pandemic was a bit unfortunate. As the company has seen a solid start to 2021, it was hurt by emerging inflation and supply chains issues in the second half of 2021.

The tie-up between Quaker and Houghton created a business with $1.6 billion in pro forma sales and a quarter of a billion in EBITDA, with synergies having the potential to increase the latter number to $300 million. At the time of the announcement, Quaker Chemical Corporation shares traded around the $170 mark, and the company carried net debt equal to about 3.4 times EBITDA. The transaction was set to create a global leader in industrial process fluids, with sales tied to metalworking, primary metals and global specialty business, creating a more diversified industrial empire.

2020 sales did end up at $1.42 billion, coming in below pro forma sales results at the time of the deal announcement following an 11% decline in organic sales. EBITDA fell to $222 million, yet leverage ratios of 3.2 times were manageable, even as adjusted earnings fell a dollar to $4.78 per share.

Quaker Chemical Corporation guided for a strong recovery in 2021 earnings on the back of stronger demand, causing shares to rally to the $300 mark in spring of that year. The company did indeed post very strong results, marking very strong momentum. In the end, the company grew 2021 sales by 24% to $1.76 billion, yet growth slowed in the second half of the year as inflation resulted in strong price growth but actually negative volume growth. Following the strong earnings power in the first half of the year, earnings for the year came in at $6.85 per share, yet fourth quarter adjusted earnings only came in at $1.29 per share.

Leverage was rapidly getting more controllable, as EBITDA improved to $274 million, reducing leverage ratios to 2.6 times based on net debt of $728 million. The company was upbeat early last year that margins could recover, yet supply chain issues and inflation were still impacting the results.

With leverage still apparent and shares traded at 26 times earnings based on earnings power of $7 per share, or 23 times earnings based on $8 in earnings per share power, shares were certainly not cheap yet. At the same time, there was more potential for Quaker Chemical Corporation shares to rally further in normal conditions amidst the realization of synergies following the tie-up.

2022 - An Eventful Year

Supply chain issues slowly eased in 2022, yet this came at the expense of higher inflation and moreover a strong dollar as well. While first quarter sales rose 10% to $474 million, adjusted earnings per share fell to $1.42 per share, as the operating conditions were still tough.

Second quarter sales rose 13% to $492 million as adjusted earnings per share fell to $1.32 per share, as the situation remained tough. A 10% increase in third quarter sales to $492 million was pretty stable, yet non-GAAP earnings of $1.74 per share look favorable compared to the earnings posted in the first half of the year, and actually mark year-over-year increases, albeit amidst easy comparables.

At this rate, Quaker Chemical Corporation was on track to generate over $1.9 billion in sales, about $250 million in EBITDA and earnings around $6 per share. Net debt is actually up to $813 million, increasing leverage ratios, mostly amidst very poor working capital performance.

Concluding Remark

With earnings power trending at $6-$7 per share now and net debt being flattish (or actually up a bit), the situation for Quaker Chemical Corporation is more or less stuck, albeit that the worst part of inflation might be over (but we might get slower economic growth, or contraction instead).

This means that the near-term situation remains quite uncertain, and all this makes it very hard to become upbeat given that Quaker Chemical Corporation shares have held up well in this environment, in fact they have risen a bit over the past year.

Given all of this, I am still appreciative of Quaker Chemical Corporation stock here, but simply do not see a compelling risk-reward scenario appearing.

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