2023-06-27 17:20:20 ET
Summary
- The company started 2023 strong, with net sales rising by 9.8% and TTM adjusted EBITDA reaching $34.6 million.
- However, sales over the remainder of the year could be stagnant or even decrease and I think EBITDA for the full year could decline below $30 million.
- Considering the enterprise value has surpassed $200 million, I think this could be a good time for investors to trim or close positions.
Introduction
In February, I wrote an article on SA about US engineering materials company Core Molding Technologies ( CMT ) in which I said that it had good organic growth and a strong balance sheet and that I expected the operating income margin to gradually improve to 10% as it passed on cost increases to its customers over the coming months.
In my view, the Q1 2023 financial results of CMT were decent as TTM adjusted EBITDA rose to $34.6 million while the net operating income margin improved to 8.1%. That being said, the market valuation of the company has soared by 40% since my previous article and sales over the remainder of the year are likely to be stagnant. I think CMT no longer seems undervalued and I’m changing my rating on the stock to neutral. Let’s review.
Overview of the Q1 2023 financial result
In case you're not familiar with CMT or my earlier coverage, here's a brief description of the business. The company specializes in the advanced fabrication of fiber-reinforced plastics and plastic composites for custom applications such as industrial fan blades, structural reinforcements, and vehicle roofs. Basically, it’s a molder of thermoplastic and thermoset structural products and its main markets include medium and heavy-duty trucks, power sports, building products, industrial, and utilities. It’s a sector with high barriers to entry and few competitors. CMT employs about 2,000 people and it operates a total of six manufacturing facilities located in the USA, Canada, and Mexico. It has a total of 80 injection molding presses and over half of its revenues came from processes and materials acquired since 2015. This is a business with about 90% recurring revenues and almost half of the 2022 sales come from the truck industry - some of the main clients include Volvo ( VOLVF , VOLAF , VOLVY ), Paccar ( PCAR ), and Navistar. Looking at the location of the production facilities, the existing asset base of CMT is situated within 150 miles of most customers.
According to CMT, its total addressable market is worth over $10 billion, and the company aims to grow in each sector besides trucks, and powersports.
In 2018, CMT launched an operational turnaround program that included the replacement of the operational management team, the implementation of new operational systems and processes, and the increase of repair and maintenance spending to improve asset reliability. The turnaround was completed in 2019 and CMT aims to grow revenues beyond $500 million per year and improve its operating income margin to 8-10% over the next 3-5 years. It plans to rely on organic growth as well as strategic tuck-in acquisitions to achieve its goals.
Between 2020 and 2022, total sales grew from $222.4 million to $377.4 million but the operating income margin inched down to 4.7% from 4.8%. The main reason for this was CMT’s decision to pass on cost increases to customers in a gradual manner and it seems that this strategy started to bear fruit in Q1 2023 as global inflation rates have been subsiding. In addition, the company mentioned in its Q1 2023 earnings call that it managed to increase the overall productivity of its plants by more than 8% during the period. Looking at the Q1 2023 financial results, net sales rose by 9.8% year on year to $99.5 million while the operating income margin came in at 8.1%. In addition, the gross profit margin was at 17.8%, which is the highest in five years, while TTM adjusted EBITDA reached $34.6 million. However, it’s worth noting that there is some seasonality in this business and that margins are usually higher in Q1 and Q2 due to the product mix.
Core Molding Technologies
Overall, I think it was a strong quarter for the company but there are some red flags. I’m concerned that free cash flow was just $2.5 million, and I doubt that it will improve over the remainder of the year as CMT plans to invest about $13 million in CAPEX in 2023 to meet current demand and add new business. In Q1 2023, CAPEX stood at just $2.1 million. In addition, it seems likely that sales over the remainder of 2023 will be stagnant or even decrease as CMT expects revenues for the full year to remain flat to slightly higher than in 2022 (see page 25 here ). Considering that most of CMT’s customers provide it with forecasts over extended periods of time, the company should have good visibility in regard to its sales. The most significant boost to revenues is forecast to come from program launches and price increases in the heavy-duty trucks segment but this is expected to be partially offset by declining revenues in the building products market. In my view, it’s possible that EBITDA for 2023 dips below $30 million due to the stagnant revenues over the remainder of the year.
Turning our attention to the valuation, CMT had a net debt of $19.4 million at the end of March 2023, which puts the enterprise value at $205.4 million as of the time of writing. The company is thus trading at a TTM EV/adjusted EBITDA ratio of 5.9x. If we assume that the 2023 EBITDA drops to $30 million, this ratio would increase to 6.8x. While this level doesn’t look high, I don’t think that CMT should be valued at more than 8x EV/EBITDA considering sales and margins could deteriorate over the coming months and that the free cash flow is barely positive. In my view, the margin of safety here has become too low as the market capitalization has soared by 40% since my previous article, and at this share price level, I’m changing my stance on the stock to neutral.
Investor takeaway
CMT had a strong start to 2023 but sales over the coming months could be stagnant, putting pressure on the share price. Considering the enterprise value has surpassed $200 million, I think this could be a good time for investors to trim or close their positions and take profits. While I remain bullish on the stock over the long term as CMT’s 3–5-year financial goals seem achievable, my rating for the time being is neutral.
For further details see:
Core Molding Technologies: This Could Be A Good Time To Take Profits (Rating Downgrade)