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Summary

  • A. Schulman announced yet another acquisition, the 9th deal in four years time.
  • The company anticipates to significantly grow revenues in the coming four years, while doubling adjusted earnings.
  • Yet the quality of earnings, given the large discrepancy between GAAP and non-GAAP earnings, are a big worry.

A. Schulman (NASDAQ:SHLM) announced yet another acquisition over the past week, this time acquiring Specialty Plastics activities from Ferro Corporation (NYSE:FOE) in its ambitions to significantly grow its business in the coming years.

The projected growth is attractive, yet the valuation is challenging, especially given the consistent and large gap between GAAP and non-GAAP earnings.

Deal Highlights

A. Schulman announced that it has entered into an agreement to acquire a majority of the assets of the Specialty Plastics business from Ferro Corporation in a $91 million cash deal.

Included in the deal are four facilities in the U.S. as well as Spanish operations. The deal is expected to close in the fourth quarter of Schulman's reporting year, which ends at the end of August. Not included in the deal are the ¨regular¨ plastics activities in Edison, New Jersey and Venezuela.

The segment supplies engineered plastic compounds, colorants and liquid coatings. The segment supplies packaging, transportation, construction, appliances and agriculture markets and clients, among others.

Implications Of The Deal

The acquired activities generated sales of $154 million in 2013 of which roughly two-thirds are being generated in the U.S. Synergies are expected to come in around $5.5 million in 12 to 18 months following the closure of the deal. Expected synergies are quite sizable in relation to reported revenues and the deal price tag. The deal values the activities at 0.6 times annual revenues, while no earnings details have been announced.

Schulman is eager to own the business, as this is the segment which attracted the company to seek to acquire Ferro last year. The deal marks the 9th acquisition being announced over the past four years, as Schulman continues to aggressively pursue growth.

The deal is significant as Schulman reports trailing revenues of $2.26 billion over the past year, which implies that the deal will add about 7% in total revenues. While Schulman stresses adjusted earnings, it is important to realize that GAAP earnings have been structurally lower in recent years, totaling just $24 million over the past year.

Valuation

Schulman operates with roughly $90 million in cash and equivalents, while total debt of $324 million results in a net debt position of roughly $234 million. The latest deal will add significantly to the debt position.

Trading at $37 per share, equity is valued at $1.1 billion. This values operations at 0.5 times annual revenues and roughly 45 times GAAP earnings. Based on projected non-GAAP earnings, shares trade at 16-17 times earnings.

The quarterly dividend of $0.20 per share provides investors with a 2.2% dividend yield.

Recent Investor Presentation

In its recent presentation held for investors in April, Schulman stressed the transformation which the company has made since 2007.

Between 2007 and 2014, Schulman increased its annual revenues at a 4%-5% rate from $1.8 billion to an expected $2.4 billion to $2.5 billion. Adjusted EBITDA grew at 6%-7% per annum to $140 million to $147 million as the company has focused on more profitable activities.

The long-term focus on plastics has served the company well with global demand for plastics steadily outpacing growth for paper and steel in recent decades.

Schulman anticipates this growth to continue, and therefore it has set ambitious targets for the year of 2018. At the time, organic growth and acquisitions should push revenues towards $3.6 billion to $3.7 billion. Returns on invested capital should increase significantly allowing earnings per share to double. For 2018, Schulman targets adjusted earnings of $4.50 to $4.75 per share.

Takeaway For Investors

The strong projected growth for the future as well as solid economic conditions have pushed shares higher in recent times. Over the past decade, shares have largely traded in a $15-$25 price range after which shares broke out in 2013 to highs of $37 at the moment

Investors appear to be pleased with the deal, sending shares a dollar higher in Wednesday's trading session, boosting the market valuation by roughly $30 million on the back of the anticipated synergies.

While the projected earnings growth sounds great, Schulman has a structural problem in my opinion. This is the large and structural gap between GAAP and non-GAAP earnings.

For that reason alone, I will take a cautious stance and am not attracted to the company. The increase in leverage being employed and the consistent low quality of adjusted earnings are the main reasons for me to exercise caution.

Source: A. Schulman - Another Accretive Deal, Yet Earnings Quality Worries Me