Shares of Olin (OLN) bounced around before and after the Q4 2012 earnings report. The chemical company's Winchester segment makes ammunition, and speculators bid shares up while looking for a surprise based on hoarding in the wake of renewed interest in gun control. When announced, earnings were a beat, and featured record EBITDA. Shares sold off, then bounced as more long-term investors responded to the fine results.
CEO Joseph Rupp has been using adjusted EBITDA as the primary metric in evaluating company performance. Here's CFO John Fischer, from the Q2 2012 earning conference call transcript, discussing the acquisition of K.A. Steel:
The combination of the 2011 K.A. Steel adjusted EBITDA of $31 million and the $35 million of annualized synergies we expect to realize, when compared to the purchase price of $328 million, reduced by the $60 million present value of the incremental tax benefits made available to Olin by the Section 338(h)(10) election, result in an EBITDA multiple of approximately 4x. We believe this is consistent with the type of post synergy multiples that were realized in both the Pioneer and the SunBelt acquisitions.
That's the financial rationale behind Olin's acquisitions -- a 4X EBITDA multiple.
After achieving a company record of $373 million adjusted EBITDA in 2012, Rupp is confident the company can reach a goal of $410 to $440 million in 2013. That equates to a 14% increase.
EBITDA As A Performance Metric
Excessive reliance on any one metric can distort the analysis of investment performance.
Both depreciation and amortization are meaningful concepts: the value of assets diminishes over time. The simple fact that depreciation or amortization can plausibly be argued to occur rapidly doesn't necessarily improve the quality of an investment, regardless of what the resulting EBITDA may imply.
Interest is a very real expense. Leaving that cost out of investment thinking is not an appropriate way of looking at things. A company that disregards the current opportunities to lower interest costs is not managing that aspect of the capital structure in the best way.
After several years of above average capex, 2013 is expected to be a light year for that type of investment. This frees up cash flow, and raises the question of how management will deploy it.
During the earnings conference call, analysts asked Rupp (twice) about increasing the dividend. Here's his second response:
Remember what we've stated. We just finished 2 years of significant capital spending. Last year, we returned $50 million, turned $40 million a year before. And of course, then made the acquisition K.A. We think that we're positioned now for a very good year, the opportunity to slash our capital spending in half. Our preference, which we stated in the past, would be to fund bolt-on acquisitions or investments in our core business. And absent that, then we will look at other methods to return our cash to shareholders.
The weighted average maturity of all Olin debt outstanding is in excess of 9 years, providing considerable financial flexibility, due to the small amounts of debt maturing over the next several years. Paying down debt is a low priority.
Looking at the above, the priorities are: bolt-on acquisitions at 4X EBITDA, capex, dividends or buybacks, then debt.
Frankly, I'm disappointed that the company isn't doing something about the dividend, which has been unchanged at 20 cents quarterly for 10 years. It's almost like Rupp thinks it's his money, and begrudges returning it to shareholders.
On the other hand, capex and acquisitions have both been conducted skillfully, in my opinion. At least investors know where they stand.
Olin has been a very successful long-term holding for me: I've made money basically buying low and selling high. I'm in the process of transitioning toward a Dividend Growth method of stock selection, and Olin doesn't make the cut, since management is unwilling to make dividend increases a priority.
After all, the final test of an investment is, does the owner get the benefit of the company's profits?