pkfawcett
This article covers Koppers’ (NYSE:KOP) 2Q24 results and earnings call. It also reviews the company’s valuation and my hold rating from Q1.
For the company’s stronger seasonal quarter, revenues were negative YoY in PC and CMC. Timing factors in PC sustained aggregate margins; otherwise, they would have fallen. Management commented that the cyclical market challenges in PC and CMC will probably continue.
As speculated in my last article, the market continued to drive the company’s share price down after the 1Q24 results. The company reached a market cap of $700 million at $35 per share a few times between June and August. Based on my model of cycle-average ROCE applied to total assets, I believe $700 million is a ceiling for a fair valuation of Koppers. If the downturn continues, we could see more opportunistic prices than that. For the time being, however, I maintain my hold rating.
2Q24 Results
The down cycle continues: On the aggregate, Koppers posted better sequential results, aided by seasonality (2Q is the strongest quarter), but on a YoY basis, revenues were down in the PC and CMC segments. I had commented on this trend before, as Koppers’ markets are naturally cyclical and volatile and are showing indications of a turn after an impressive bull market in 2022/23.
CMC, a year in deep negative territory: Since 3Q23, CMC has been posting bad comparables. In 1Q24, the segment was down 20%; in 2Q24, it continued to be down 18%. Although the comparables should naturally improve in 3Q24, management commented that they do not see an improvement, at least until the end of the year. They have reduced their CAPEX plans for the segment by $10 million. I have long struggled to understand why CMC receives more CAPEX funds than the much larger and profitable PC segment, so this development is partly salutary.
PC flat with commodity tailwinds: The PC segment was down 2%, but mostly because it had to record some sales to the acquired Brown Woods as an intercompany; otherwise, it would have been almost flat. The company’s adjusted EBITDA margins were impressive at 25%, but management warned that these were caused by temporary cost recognition and hedging factors (as copper prices have been volatile, causing disparity between CoGS and pricing). Management commented that this segment’s long-term normalized adj EBITDA margins should be in the high teens. On the dynamics front, home construction is flat for the year, and renewals are down. This segment is heavily influenced by US home construction/renewal activity and is, therefore, in a risky situation considering the current macro slowdown outlook.
RUPS up on acquisition: The RUPS segment was up 8%, pushed mostly by pricing improvement, which also helped elevate margins to 8.8% (from 8% last year). Pricing improvements tend to lag cost increases, as was commented on in previous articles. Still, management believes that the positive comparable trend should continue for this year. The segment also saw volumes increase mainly because of the acquisition of the Brown Woods utility pole business. The RUPS segment is driven by utility and railroad CAPEX and should, therefore, be a little more shielded from macro conditions. On the contrary, the segment is benefited from a secular tailwind in infrastructure investment in the US, and energy transition CAPEX globally.
Debt up: Net debt was up $100 million QoQ because of the Brown Woods acquisition and reached $945 million, or 3.7x EBITDA, a relatively concerning figure. If we also remove maintenance CAPEX of about $50 million and interest payments of $75+ million, then we are talking of 9x current FCF. The multiple is higher based on cycle-average figures (as we will see below). I hope that Koppers starts decreasing that leverage soon. The company has been dedicating capital to acquisitions, share repurchases, and dividends that may be better used in debt repayments. Debt is one of the main reasons I believe the company demands a higher rate of return.
Valuation Approached Fair; Could Become Opportunistic
On the valuation side, the stock continued to drive lower after the negative 1Q24 reaction. I also commented on this possibility in my last article on Koppers. Cyclical companies’ stocks tend to overshoot on both the upward and downward portions of the cycle because of concerns regarding leverage. Given Koppers has high financial leverage, I believe the downward overshooting could be worse.
My fair valuation for Koppers is based on using cycle average ROCE applied to the company’s current asset base. We should update the model for the acquisition of Brown Woods. The company’s long-term cycle-average ROCE was 8.8%, and as of the last quarter, it boasts total assets of $1.95 billion. This implies a cycle-average operating income of $170 million. If we remove approximately $75 million in interest payments (based on the latest $985 million in debt and financing at averages of SOFR + 2%), plus taxes at 25%, we arrive at $71 million in cycle-average net income. This is not very different from the figure from last quarter, basically because the ROCE we apply to the Brown Woods acquired assets is similar to the company’s cost of debt.
From this, I believe the ceiling of a fair valuation to Koppers is 10x cycle-average valuations, or $700 million. I say ceiling because, in my opinion, a 10% earnings yield for a chemical company with financial leverage is the bare minimum return.
The company’s stock touched this valuation a few times last quarter at $35 per share. I believe that if macro conditions worsen, or (as management in part commented) the company’s market conditions do not improve quickly, the stock could test lower prices than that fair valuation ceiling.
For that reason, I believe that Koppers is not currently an opportunity and maintain my hold rating. I will keep a tab on the stock for opportunities below $30.
