ZCL Composites Storming Out Of The Oil Recession

| About: ZCL Composites, (ZCLCF)

Summary

ZCL is a successful turnaround story in the midst of oil recession.

Investor-friendly management keeps raising dividends.

Valuation neglects growth prospects.

Canadian industrial sector has been absolutely shattered due to the aggressive declines in oil prices. Most of these operators are still healing their wounds while one company, ZCL Composites (OTC:ZCLCF), completed its stealth turnaround.

ZCL weathered oil recession well

ZCL Composites is a manufacturer of tanks used mostly for oil/petroleum storage. Above-ground segment products are sold to oil producers, power generation and other heavy industrial players. Underground tanks are mostly made for petroleum marketers and gas stations in Canada and more so in the US. Further, ZCL builds water storage tanks in the underground reporting segment.

ZCL's above-ground business is very sensitive to oil price fluctuations. As a result, Alberta's recession hurt ZCL badly since late 2013 and throughout the past two years. At the end of 2012, the above-ground segment represented over 30% of the total revenue as illustrated in the table below. In addition, above-ground offers a better margin. The combination of declining revenue and margin compression put a lot of pressure on the company's bottom line up until the end of 2015.

Faced with this tough reality, management responded by putting more emphasis on expanding the underground business which is benefiting from positive secular trends. Main drivers are listed below:

1. Customers' preference for ZCL's fiberglass storage tanks over steel tanks

2. US gasoline marketers and retail stations are experiencing higher profits due to lower oil prices, thus spending more on capital expenditures

3. Aging gasoline tanks need to be replaced

Management anticipates continued strong growth in underground revenue in the future, combined with margin expansion on the way. I believe now is the turning point for the company as negative impacts from the above-ground segment is mostly limited. Given its 90/10 split in its underground and above-ground business as at the end of 2015, I think we will witness accelerated growth in the company's overall performance. Note, ZCL's 2015 earnings were essentially the same as those of 2014. This is about to change this year in my opinion.

Investor-friendly management

In addition to being an excellent operator, the management keeps a very lean capital structure and distributes any excess cash in dividends. In 2016, the company announced a 60% increase in dividends and a one-time special dividend of $0.50. My personal preference is dividends over share buybacks because dividends ensure all shareholders get a fair share of the company's success.

At $8ish a share, the dividend yield is sitting at 4%.

Valuation

The company trades at about 16x last year's EPS multiple, undervalued considering its growth rate. The company expects 10% annual revenue growth moving forward. Earnings growth could easily exceed 15% benefiting from operational leverage.

Recommendation

ZCL Composites is a great organic growth story in Canada. I expect steady growth in the upcoming years as long as the US economy holds its ground. Further, this is a great buy and hold if you are a dividend growth investor.

Buy the stock ahead of the Q1 earnings release. I think the probability is high that the company will significantly outperform against last year's figures.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ZCLCF over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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