AMCOL International Corporation (NYSE:ACO) has been doing fairly well in its Performance Materials and Construction Technologies' segments, but its Energy segment continues to be challenging for the company, and the successful implementation of a strategy to address cost and margin issues related to the unit will determine how the company performs going forward.
Latest Quarterly Results
Company sales for the third quarter of 2013 climbed 5.7 percent, led by the 8 percent gain by its Performance Materials unit. Energy Services and Construction Technologies grew by approximately 5 percent each.
Including two impairment charges, the company lost $0.61 in the quarter. The largest impairment charge by far was for $52.3 million, or $1.08 per share from its writeoff of assets held in South Africa. Much smaller was the $4.2 million in writedowns, or $0.13 per share, associated with its health and beauty business which the company is divesting itself of.
Even so, the major hit was gross margin, which fell 120 basis points, with its Energy Services unit falling 640 basis points to lead the margin plunge.
Reasons for Gross Margin Weakness
There were two key reasons for the plunge in gross margin in the energy division of AMCOL, and those were challenges in Malaysia and low demand for service capacity in the North American market.
In North America it's the ongoing pricing pressure from oversupply, which will take some time to balance out. With Malaysia it's poor management in conjunction with projection of costs related to the fabrication of capital equipment.
No specifics of what the company is going to do to take care of the cost estimation debacle have been proffered, although it has asserted it is "aggressively" dealing with the situation, and expects the results in Malaysia to be better in the fourth quarter.
The Performance Materials segment of AMCOL includes metalcasting and basic materials. Metalcasting is the largest part of the segment. The biggest user of its products is the auto industry. Part of the segment includes basic materials, which sells bentonite for the pelletization of iron ore and additives for drilling fluids.
Metalcasting has been doing fairly well, with the exception of chromite sales. Not including chromite, metalcasting generated sales growth of 19 percent in Asia and remained level in the United States. Foundry products based on bentonite were the positive drivers. Gross margin for these products has also improved.
As for chromite sand, a weak steel casting market has lowered demand and margin. Gross margin dropped from the low-20s to the low-teens in the most recent quarter. There are no visible catalysts to suggest a change in that market anytime soon. It will probably get worse before it starts to level off. Chromite sand made up only 8.5 percent of metalcasting revenue in the latest quarter.
On the basic materials side, it grew revenue by 7.5 percent to $1.1 million. The strongest product here was bentonite sold for iron ore pelletizing. In this business line some of the non-foundry grades of chromite increased in sales. The chromite that performed poorly was that used in foundries.
Strong competition and lower demand resulted in a drop in revenue from drilling fluid additives for land-based drilling.
Specialty material products within the segment has grown, with sales jumping in the third quarter of 2013 by $2.6 million, or 12.2 percent. The major catalyst in specialty products is fabric care, where sales jumped 26 percent. Demand for its existing product line is the key driver there. Margin has also improved.
Also part of Performance Materials is bio-ag and pet products. Bio-ag is in the formative stages, and adds nothing to the bottom line of the company at this time. Pet products boosted sales by 32 percent, with gross margin also getting better.
While sales growth in fabric care and pet products look impressive, the amount of sales aren't near enough to make much of a difference in the peformance of the company at this time.
Continued weakness in land-based drilling and chromite sand for foundries is offsetting the strength in bentonite. Consequently, in the Performance Materials will be fortunate to break even. It is unlikely to continue to boost sales and earnings going forward. Gross margin will remain level and sales drop to 1 percent to 2 percent, if it grows at all.
Construction Technologies Segment
This segment includes building materials, lining technologies and drilling.
The product line in building materials has been weak, mostly as a result of the ongoing recession in Europe. While the company has several major instructure projects in the U.S. ready to start, I don't see building materials recovering in the near future.
Within lining technologies it looks a little more promising, although the landfill market remains very weak. Some mining and industrial projects may make up for that, and it appears this area of the company is one that will grow in the short term.
The drilling products part of the segment remains challenging, as sales in the large U.S. market continue to be flat, and that isn't expected to change soon. Longer out drilling may improve as more demand for pipeline and utility placement grows.
Overall the Construction Technologies Segment looks like it will break even or maybe grow slightly going forward. Oversupply is again a problem in some of the key markets the company serves, as well as the weakness in Europe, which has no end in sight.
Filtration Business within Energy Services Unit
The reason for the sales increase in the otherwise dismal performance in the last several quarters for the Energy Services division has been its filtration business.
In the first two months of the most recent quarter the filtration business underperformed, although initiatives to boost sales and reduce costs in September helped AMCOL to generate revenue there. Again, the margins in the quarter in the unit plummeted because of pressure on pricing from oversupply.
Why this is important, and possibly something that is being missed by investors, is it points to management problems within the Energy segment. I conclude that when two different markets within a segment experience similar performances from lack of understanding market demand and inability to properly ascertain costs, it points to management issues.
There have been no firings that I have heard of, which generates concern over exactly what the company is doing about the segment to turn it around. Incompetence is definitely part of this picture, and it has to come from the top where apparently the leadership doesn't have a handle on what's going on, and isn't supervising, effectively training, or getting rid of the appropriate people responsible for the big mistakes that were made.
If it wasn't for the sales increase in the filtration business, this division would have performed far worse than it did, which would have hit the share price even harder. Shareholders and investors need to know exactly what is being done to turn this around, other than saying it is being aggressively addressed.
AMCOL's Overall Energy Segment
With the poor performance of the Energy Segment weighing on AMCOL, it would be a good idea for the leadership in the company to seriously consider whether or not to retain that business.
When that was suggested to Chief Executive Officer Ryan F. McKendrick, he pushed back against that idea, saying, "it does make sense for it to be in the AMCOL portfolio of businesses."
The major reason given was concerning its coil tubing service within the Energy Segment of the company. McKendrick said the company can differentiate because of its patented technology.
In the coil tubing business the company separates itself from competitors by being able to clean internal pipelines to the full diameter of the pipe. AMCOL recently acquired the technology, and since that time has generated over $900,000 in business. That already accounts for over 10 percent of the monthly coil tubing business of the company in a short period of time.
Even so, with that new technology which enables the company to differentiate from its competitors in one part of the energy business, McKendrick admitted the company will likely never return to its former gross margin range of over 30 percent. Rather he sees the segment operating with a gross margin in the mid-20s starting in the fourth quarter. Overall top line growth in 2014 is projected to be in the upper single-digits for the unit.
The bottom line is the energy unit isn't going to perform as it has in the past regarding gross margin, and that will be detrimental to the performance of the company. Pricing pressure is the major culprit, and that means competition, along with supply and demand, makes this a weak segment of the company, although it if is able to generate more sales, the higher sales could partially overcome the weaker gross margin that is now inherent in the energy unit of AMCOL.
Cash Flow, P/E, Debt
Another concern is the cash flow of AMCOL, where operating cash flow fell by close to $16 million year-over-year. Free cash flow plummeted by $28 million, which was of course the consequence of the lower operating cash flow as well as a boost in capex.
Debt in the latest quarter jumped by $22 million.
With all of these challenges, some still see AMCOL still as having strong earnings potential, as its trailing P/E (NYSE:TTM) is 56.66, and its forward P/E (fye December 31, 2014) is 13.94.
This appears to be the case because of company guidance concerning expected revenue growth across all segments of the company. That speaks to the idea revenue is believed to be able to overcome the significant gross margin challenges of the company.
With consolidated net sales of AMCOL led by its Energy unit, how it is able to respond to gross margin will determine the performance of AMCOL going forward. In 2012 the Energy Services segment accounted for 26 percent of consolidated net sales.
source: annual company report
The share price of AMCOL has unsurprisingly been volatile over the last year, moving in a range of $27.59 to $37.05 during that period.
Even with some expecting improved earnings, the overall market rightly remains somewhat skeptical concerning the ability of AMCOL to deliver on its guidance.
Performances over the last year across all the segments of the company have been up and down, with its Performance Materials and Construction Technologies segments underperforming earlier in the year.
That points to an inability to bring the disparate parts of the company together. AMCOL leadership claims it has done that by asserting all segments will boost revenue in the next quarter and onward. Recent past performance suggests otherwise, and until the company proves it can back its assertions, it's going to struggle to gain momentum.
Add to that the apparent permanent fall of gross margin in its Energy Services segment, and it is hard to see a lot of headwind for the firm.
Since 2010 the company share price has grown by only a little over 10 percent, confirming it has been performing flat during that time.
The internal thesis of AMCOL is unconvincing, and until it backs up its assertions with performance, I would wait before taking a position in the company. AMCOL will probably continue to be volatile until it puts together several quarters that point to it consistently generating positive earnings across all its segments. I look for it to continue to perform as it has been, which means it'll remain flat and move within the range it has been for the last three years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.