2023-11-14 02:47:14 ET
Summary
- Core Molding Technologies’ net sales went down by 14.6% in Q3 2023, but its operating income rose by 26.8%.
- Also, free cash flow for the first nine months of the year was $19.3 million and net debt is down to $10.1 million.
- CMT stock is trading at an EV/adjusted EBITDA ratio of 3.9x on a TTM basis and I think the recent selloff has created a good buying opportunity here.
Introduction
I’ve written two articles on SA about engineering materials solutions firm Core Molding Technologies (CMT), the latest of which was in June when I said that the Q1 2023 financial results were decent but that sales over the remainder of the year were likely to be stagnant.
On November 7, CMT released its financial results for Q3 2023 and net sales for the period fell by 14.6% year on year. The market capitalization has shrunk by just over a third since then, but I think the market has overreacted here as the situation doesn’t look that bad when you dig deeper into financials as operating income grew by more than a quarter and free cash flow for the first nine months of the year was over $19 million. In addition, CMT has strengthened its balance sheet over the past few quarters, and it had over $18 million in cash as of September. I’m upgrading my rating on the stock to a speculative buy. Let’s review.
Overview of the Q3 2023 financial results
If you aren't familiar with the company or my earlier coverage, here's a brief description of the business. CMT was established in 1980 and is a molder of thermoplastic and thermoset structural products that serves the building products, utilities, transportation, and powersports industries. This is a market characterized by highly-engineered products and this creates high barriers to entry. According to the company’s latest presentation, some 90% of revenues are recurring in nature (see slide 4 here ) and I think there is a good moat here. In addition, there is decent visibility for sales as CMT’s clients provide forecasts over extended periods of time. The business is characterized by slight seasonality as margins are usually higher in Q1 and Q2 due to the product mix. CMT has a total of six production facilities across the USA, Canada, and Mexico and it employs close to 2,000 people. The company claims that the total addressable market is worth over $10 billion (see slide 5 here ) but I’m concerned that around two-thirds of net sales come from the truck and power sports markets. In addition, five customers account for about two-thirds of revenues – BRP (DOOO), Volvo (VOLVF)(VOLAF)(VOLVY), Paccar (PCAR), Navistar, and UFP Industries (UFPI).
Turning our attention to the Q3 2023 financial results, we can see that net sales went down by 14.6% year on year to $86.7 million due to lower tooling project sales as well as lower demand from the power sports, building products and industrial markets. In my view, the lower net sales are unsurprising considering CMT said that it expected revenues for the full year to remain flat to slightly higher than in 2022 when it released its Q1 2023 results (see page 25 here ). On a positive note, the operating income grew by 26.8% to $5.9 million in Q3 thanks to efficiency improvements as well as declining raw materials costs. The operating income margin rose to 6.8% from 4.6% a year earlier and CMT said during its Q3 2023 earnings call that it had achieved a 19% overall productivity improvement by October. When I covered the company in June, the productivity improvement achieved in Q1 2023 was just 8%.
Looking at the balance sheet, net debt was down to $10.1 million at the end of Q3 2023 from $27.1 million at the end of December 2022 as CMT used the majority of its $19.3 million free cash flow for the first nine months of 2023 to boost its cash position. Between December and September, cash and cash equivalents increased by $13.9 million to $18 million. The company mentioned during its Q3 2023 earnings call that it plans to execute and integrate an acquisition in 2024.
Looking at what to expect for the future, CMT said that net sales for Q4 2023 could decrease by 15% to 20% year on year due to customer de-stocking as well as the impact of UAW strikes on its clients. On a positive note, the company continues to target gross margins of 17.5% to 18.5% for the full year which means that the operating income margin in Q4 should be at similar levels to Q3.
Turning our attention to the valuation, CMT has an enterprise value of $162.1 million as of the time of writing and is trading at an EV/ adjusted EBITDA ratio of 3.9x on a TTM basis. The company has a decent moat, and the strength of its balance sheet as well as its the free cash flow have improved but there is significant exposure to the cyclical truck industry, and I think it should be trading at about 6x EV/EBITDA in this uncertain macroeconomic environment. In my view, the recent selloff has created a compelling window of opportunity to open a position here.
Looking at the downside risks, I think the major one is that I could be underestimating the headwinds that the business is facing at the moment. CMT said that industry analysts expect a demand decrease in the North American heavy-duty truck market in 2024 (see page 26 here ) and this means that revenues next year could decrease even if the company makes an acquisition. In addition, CMT warned that it expects to face headwinds from macro-economic tightening as well as the end of life of certain programs in 2024. Another risk here is that just five customers account for the majority of revenues, which means that the loss of even a single one of them could have a significant negative effect on the business.
Investor takeaway
The business of CMT is facing headwinds at the moment but the company has improved the production efficiency of its facilities considerably over past several months and I think that operating income and adjusted EBITDA could continue improving even if net sales continue to fall over the next few quarters. The company has a good moat and a strong balance sheet, and I think there is a decent margin of safety here as a result of the selloff following the release of the Q3 2023 financial results.
For further details see:
Core Molding Technologies: Q3 FY23 Results Were Not That Bad (Rating Upgrade)