WOR - Worthington Industries: Strong Despite Some Cracks

Summary

• Worthington Industries is a long-term value creator in a cyclical industry.
• The company is seeing some tougher times, but underlying performance remains solid.
• I like the Worthington Industries business and its potential, certainly in anticipation of a 2024 split-up, which should create more value.

In the summer of this year, I concluded in this premium marketplace article that shares of Worthington Industries, Inc. ( WOR ) were worth a look here. I observed a great long-term track record, improvement in the business positioning, and savvy strategic choices, as the company took chips off the table following the sale of Nikola ( NKLA ) shares ahead of its major downturn.

A Recap

Worthington is a large and diversified industrial manufacturer. Given the many moving parts in my eyes, I often look back to 2019, still to be regarded as a reasonable regular year to establish a "base.

At the time, Worthington Industries generated $3.8 billion in sales on which relatively modest operating earnings of $145 million were reported. The business relies heavily on steel processing (responsible for $2.4 billion in sales) accompanied by mid-single-digit operating margins, as well as a $1.2 billion pressure cylinder business with a similar margin profile. The engineered cabs business was small, with just a hundred million in sales, as the company lost $15 million on these activities.

The company earned about $1.50 per share that year, as there were many moving targets. This included a big dollar headwind, losses at the engineered cabs business, and the fact that the company has many joint ventures, which are not consolidated. From its stake in multiple joint ventures, the company earned approximately $100 million that year, that is its stake in their financial performance.

Moreover, the company held 19 million shares in Nikola which went public in 2020, traded near the $100 mark for a couple of months, although this is now just a $2 stock of course. With shares trading at $40, the $1.50 earnings per share power did not look that interesting, yet including the earnings from the JVs, the losses being potentially halted at engineered cabs, normalization of operating performance, there were many moving targets to create value.

In fact, that happened as shares rallied to $67 in March 2021, driven by a recovery in the cycle, as I took a few chips off the table. After a tough 2020, the company posted sales of a mere $3.2 billion in 2021, yet operating earnings of $168 million and equity income of $123 million from joint ventures were quite comforting. On the back of improved earnings power and sale of Nikola shares, the company acquired Electrical Steel Company Tempel Steel in a $377 million deal.

With earnings power improving, the company is announcing another bolt-on deal. The 49 million shares represented a mere $2.3 billion equity valuation at $47 per share, albeit that the enterprise value rose to $3.0 billion if we factor in net debt. Even as earnings momentum around $6 per share likely was not to be maintained, it provided a great earnings yield in the meantime to generate cash flows and drive value.

Rangebound

Since the summer, shares of Worthington have essentially traded in a $40-$60 range, now trading in the middle of the range at $50 per share, as markets at large have been struggling as well. Towards the end of June, the company announced its results for 2022, a spectacular year in which revenues jumped by more than $2 billion to $5.2 billion. Operating earnings were reported at $329 million and some $214 million in equity earnings were reported.

GAAP earnings came in at $7.44 per share, with adjusted earnings of $7.30 per share coming in more than two dollars ahead of last year. While the outlook was perhaps less bright, the company hiked the dividend by 11% to $0.31 per share, translating into a modest payout and a very modest 2% earnings yield.

In September, the company posted first quarter results with earnings reported at $1.61 per share on a non-GAAP basis, with GAAP earnings coming in a bit lower, mostly due to a $0.25 per share charge related to the sale of its equity stake in ArtiFlex. With net debt coming down gradually and the economic picture being mixed, but manageable, the company had a big announcement in place.

The company announced its plan to separate the Steel Processing business, a huge spin-out, yet the transaction is only set to be completed by early 2024, still a long way to go but a potential trigger down the road. Earlier this week, the company posted second quarter results with revenues down 5% to $1.18 billion on the back of steel price declines.

This made that earnings took a huge beating, with adjusted earnings posted at $0.44 per share. The lower earnings power had a big impact on cash flow generation, actually a positive one due to working capital gains on the back of lower prices, with net debt down to $569 million. Despite uneven economic conditions, steel prices have stabilized and customers hold more normal inventory levels, as the focus of the business will be on the separation in 2024 of course.

What Now?

The $0.44 per share earnings number for the second quarter is better than it looks, as the inventory losses on steel totaled $53 million, equal to $0.81 per share, as that should cancel out over time. Hence, it is still quite reasonable to maintain a roughly $5 earnings per share estimate, despite the uneven economic conditions here.

The question is, of course, at which valuation the Steel Processing business can be spun-out. The remaining business, which is comprised out of building products, consumer solutions, and renewable energy solutions, posts superior margins and should enjoy a meaningful higher earnings multiple.

Hence, I view the situation as favorable, and while there are many questions to be asked and answered, I like the setup here, remaining an avid holder of Worthington in anticipation of a long-awaited spinoff.

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