For roughly a year, CP Applied Technologies (NYSE:GCP) has been trading as a standalone business after it was spun off from W.R. Grace & Co. (NYSE:GRA). In traditional fashion for spin-offs, shares underperformed in the first weeks of trading, as investors in W.R. Grace sold their holdings. Yet at $15 per share, the prospects looked very good in relation to the valuation as shares embarked on a rally that would take shares to levels as high at $30 by September.
With third-quarter sales disappointing, and investors cashing in on some gains, shares have retreated toward $26 at the moment. Shares have not benefited at all from a post-election rally. This is despite the fact that GCP is well-positioned to benefit from greater infrastructure spending and economic growth. Applying a 15x multiple to potential adjusted earnings of $1.50 per share this year, I see some appeal at $22-$23 per share, with the lower multiple being reflective of the above0average leveraged balance sheet.
Who Is CP Applied?
GCP has a long history, being founded nearly a century ago as part of its predecessor, W.R. Grace. This company is now made up of three segments, which, when combined, generated sales of nearly $1.4 billion through the 12 months leading up to September 2015.
The specialty construction chemicals business is the largest segment. It generated $718 million in sales, holding leading positions in cement additives and concrete admixtures. Adjusted EBITDA of $106 million translated into margins of nearly 15%. This segment is very well-diversified across the globe, having a substantial presence in Latin America, Asia and Europe.
The specialty building materials business is a leading producer of pre-applied water proofing membranes, used for weather barriers and fire protection. Most of these solutions are used to protect real estate from water, such as from storms. This $393 million business generates a hundred million in adjusted EBITDA, for margins of 25%. Just like the specialty construction chemicals business, this business has delivered on solid organic growth in recent years, offset by the impact of a strong dollar as a substantial part of the business is overseas.
Darex Packaging Technologies is a producer of can sealants used in food and beverage industries. This $341 million business posted adjusted EBITDA margins of $78 million, for margins of 23%. This business is a truly global business, with North America being responsible for just one-fifth of total sales. Unlike for the other two divisions, revenue trends have not been that impressive in recent years.
There is a big discrepancy in the original company presentation. Reported pro-forma sales of $1.37 billion are lower than the sum of segment revenues, which came in at $1.45 billion. Overall reported adjusted EBITDA of $237 million was substantially lower than the sum of segment EBITDA, which came in at $284 million. These discrepancies are the result of the impact of the devaluation in Venezuela. As a result, the corporate revenue and EBITDA numbers exclude the contribution of these businesses, while they were still included in the segment results.
With 60% of overall sales being generated abroad, GCP has seen severe currency headwinds in recent years -- notably for its operations in Latin America, which contribute 10% to overall sales.
The company kindly provided a 10-year overview in its spin-off-related presentation. This shows that sales were quite resilient during the 2009 recession, with sales down just 10%-20% from the 2007 peaks.
Margins were quite resilient as well. Adjusted EBITDA margins bottomed at 13% in 2011, down just three percentage points from the peak in 2007. The company has steadily expanded margins ever since, approaching the high-teens ahead of the spin-off.
There is the theory that spin-offs often relate to underperforming assets in which a motivated management team can deliver on great margin improvements. GCP had already made huge achievements in terms of its margins in recent years, making it difficult to redo this trick again once it became a separate business.
Not In Demand
Following the spin-off in January of last year, shares quickly fell from $20 to a low of $15 in February 2016. Forced sellers, for which the market capitalization of GCP was too small, or who were not familiar with the business, sold their stub. This put pressure on the shares at a time when the market was facing a lot of turmoil.
At $15 per share, GCP's equity was valued at $1.05 billion. While the company already indicated at the time of the spin-off that it expected adjusted earnings of $1.38-$1.55 per share for 2016, investors sold their holdings, trading at just 10x adjusted earnings. That seemed like a low multiple for a company that guided for sales growth of 4%-6% on an adjusted basis.
Part of the conservatism had to do with leverage. W.R. Grace has saddled the company with a net debt load of $689 million, excluding net pension related liabilities of another $55 million. The company guided for adjusted EBIT of $210-$225 million in 2016, with D&A charges running at roughly $35 million a year. That suggests EBITDA was seen at roughly $250 million in 2017, for a near 3x leverage ratio.
Market Becomes Upbeat
After bottoming at $15 per share in February, shares started on a huge rally that pushed shares up as high as $30 in September. First-quarter adjusted sales were up by 6.1%, yet second-quarter adjusted sales growth slowed to 3.7%.
After peaking in September, shares have sold off to current levels of $26 per share, having missed out on the post-election rally. With growth slowing down and having seen a huge rally since February investors were taking profits, as adjusted sales fell by 0.7% in the third quarter driven by weakness in North America, Turkey and the UK. This prompted the company to cut the full-year adjusted earnings guidance from $1.38-$1.55 per share, toward $1.38-$1.45 per share. Flat growth, a leveraged balance sheet and a steep 20x adjusted multiple implied that a $30 valuation probably was a bit too steep.
Some good news was announced as well. GCP completed the purchase of Halex Corp., a supplier of flooring products. This $47 million deal valued Halex at 1x annual sales of $45 million. This marks a substantial discount from GCP's own sales multiple of 1.7-1.8x.
While shares have retreated to $26 per share, they now trade at 18x adjusted earnings for this year, while the balance sheet is fully used. This observation and lack of growth in the third quarter is concerning. On the other hand, the business is resilient, has high margins, and offers real diversification as well as a play on growth.
Applying a modest 15x multiple onto projected earnings of $1.50 per share for 2015, thereby taking into account above-average leverage. I am a buyer around $22-$23 per share.
Disclosure: I/we 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.