- Due to a large goodwill write-off and very disappointing Q2 results, the stock dropped ~25% within two days.
- The thesis played out as I feared. The stock had significant downside before the turnaround was complete. Downside risks, including high debt and short interest, should be fully hedged.
- Thanks to goodwill impairment and a massive stock price fall, now is a good time to buy. I update my price target to $15 to be reached within 3 years.
A.M Castle & Co. (NYSE:CAS) reported very disappointing Q2 earnings (SEC filing, presentation, conference call). Consolidated net sales were $249.5M for the three months ended June 30, 2014, compared to $273.4M a year ago and $253.4M in the first quarter of 2014. Net loss was $72.3M, or $3.10 per diluted share. This included a $56.2M non-cash goodwill impairment charge. Excluding the impact of the impairment charge, adjusted non-GAAP net loss for Q2 2014 was $22.9M compared to net income of $0.4M a year ago. EBITDA loss was $62.0M compared to EBITDA income of $5.1M a year ago. Adjusted EBITDA, which excludes the goodwill impairment charge, was a loss of $5.6M compared to adjusted EBITDA income of $11.6M in the second quarter of 2013.
These very weak results clearly show that the goodwill impairment was not the only reason why the total results disappointed. The underlying business has deteriorated as well. Net sales from the metals segment - which accounts for ~90% of sales - were $214.1M, or 10.6% lower Y/Y and 2.3% lower Q/Q. Lower pricing and product mix accounted for a 7.4% decline and lower sales volumes accounted for the remaining 3.2% decline Y/Y. The segment sales decline from Q1 was primarily due to lower volumes. On one hand, this shows that prices stopped falling. On the other hand, volumes were hurt, showing weak demand and competitive pressures. In the plastics segment, net sales were $35.4M, or 4.2% higher Y/Y and 3.1% higher Q/Q. The automotive, marine and life sciences sectors continue to perform well for the plastics segment, but the share of plastics segment on overall sales is still too low to make a significant positive impact. Tax rate in the next couple of years should be very low at ~12% due to valuation allowances and goodwill impairment.
The most important remarks from my original thesis published a year ago played out as I feared: "I expect the stock to trade well below the book value before improving, because almost all the factors of my analysis lead me to expect further sale declines, falling average selling prices and margin stagnation at best in the next few quarters" because CAS is in the "early to middle stages of its massive restructuring, and it will take a couple more quarters for a turnaround to clearly materialize. Deep value investors should wait for a potential stock price pullback of up to 20% before making the bulk of purchases". Also, "if we experience a cyclical downturn, the 40% downside stock price risk might materialize". And finally, "From analyzing this and other cyclical companies, I definitely recommend at least a partial hedge". I am now more confident in taking a long position in CAS due to the massive stock price decline in the past six months - induced partly by the rapid fall in iron ore prices in 2014 - and due to the large goodwill write-off. I am updating my price target downwards to $15 per share within the next three years, offering ~75% total upside. However, I strongly urge investors to fully protect the downside with ATM put options because risks of further deterioration are high. The debt is high and increasing in absolute terms as well as relative to falling sales, EBITDA and market cap. The short interest is also high and reached 20% recently. Moreover, the PMI released today showed the largest drop since 2008, increasing downside risks for A.M. Castle.