Versum Materials: Insider Buys Prove Timely As This Air Products' Spin Off Transforms

| About: Versum Materials (VSM)


The company’s recent quarterly report showed it exceeding earnings estimates while delivering strong revenue growth and maintaining strong adjusted EBITDA margins.

The company has set out a series of fiscal 2017 priorities for the company to drive revenue/earnings growth and long-term shareholder value.

The company is focused on successfully transitioning to being a standalone company; building a results oriented culture; enhancing productivity; and delivering profit growth.

The company has already achieved industry-leading margins by exiting unprofitable business lines, improving its product mix and moving production to Asia.

Multiple late 2016 insider purchases have proven timely as the company embarks on its transformation and growth strategies. Buy the company’s shares on market weakness.

Versum Materials (NYSE:VSM), the former materials technologies division of Air Products and Chemicals (NYSE:APD), offers specialty gases, specialty chemicals, services and equipment to the electronics industry. The company also offers performance chemical solutions for a number of industries including coatings, inks, adhesives, personal care, institutional and industrial cleaning, and mining. VSM's most recent quarterly earnings report showed it recording a profit of $50.8 million (47 cents per share), exceeding analyst estimates. The company also recorded revenue of $270.8 million for the quarter. When commenting on the quarter, VSM noted that it had delivered strong revenue growth while also maintaining its strong adjusted EBITDA margins. Further, VSM indicated that it is a premier supplier of materials to the semi-conductor industry characterized by strong growth prospects, high margins, low capital intensity, and strong cash flow generation. As VSM has begun its "life" as an independent company free from the constraints of its former parent APD, it has set out a series of fiscal 2017 priorities for the company to drive revenue/earnings growth and long-term shareholder value.

VSM, as a newly independent company, is focusing on four important objectives that it believes will establish a strong foundation to drive future value for its customers and its shareholders. Such objectives include: 1) a successful transition to a standalone company; 2) building a results-oriented culture; 3) enhancing productivity; and 4) delivering future profitable growth. With respect to company culture, accountability and customer focus, VSM has set clear targets for all of its business line leaders and their teams so that they can feel energized and accountable for the results that they can directly control. Such accountability is important to ensure that all VSM's businesses are performing at their full potential. To allow for top performance of VSM's businesses, the company has a customer centric business model whereby it has moved more of its resources and capabilities closer to its customers, so that it can collaborate with such customers quicker and more efficiently. Moreover, VSM's business teams work to support their customers' innovation initiatives and ensure a reliable supply of all its products to such customers.

With respect to VSM's productivity initiatives, the company is primarily focused on optimizing the performance of its organic resources to its existing operations and enhancing them through capacity de-bottlenecking and selective expansions. In addition, the company indicated the critical nature of its building in 2017 its standalone infrastructure and capabilities. The company is within its expectations in terms of both cost and timeline for establishing its own independent governance and administrative structuring and transitioning from service agreements with APD. VSM is also in the midst of relocating its research and development facilities by late summer 2017. Further, with respect to the company's profitable growth initiative, it is focused on delivering on its financial targets. In particular, VSM's latest quarterly results were a positive beginning as it remains focused on revenue growth, while maintaining its strong margins. Part of the company's effort to drive profitable growth includes its pipeline of projects. With this in mind, let us take a look at VSM's quarterly results in more detail.

VSM noted that its most recent quarter occurred during a very strong quarter for the overall semiconductor industry despite the fact that its fiscal first quarter is normally the beginning of the slower half of the year. The strength the company experienced for this quarter was broad-based and included semiconductor-sales, semiconductor-unit shipments, equipment spending, and foundry sales. The company expects continued solid growth prospects for the remainder of 2017 due to key semiconductor industry trends, including foundries that are ramping 10 nanometer advanced logic, DRAM that has stabilized and it sees demand strengthening. The company also noted that VNAND rams continue to be driven by strong demand in storage class memory, advanced logic for servers and cloud computing remaining strong, the PC market which appears to have stabilized and perhaps even grow in fiscal 2017, and demand for auto and industrial ICs remaining strong. With near-term positive trends in mind, let us look at VSM's financials for the latest quarter.

VSM posted a strong quarterly financial performance as both its materials and delivery systems and service business benefited from strong industry demand trends and customer ramps in both logic and memory. The company's sales increased 10 percent from the year-ago quarter as its materials business sales volumes increased for both advanced materials and process material products, partially offset by price mix. The company's delivery systems and services also recorded strong quarterly results due to strong equipment sales. Adjusted EBITDA increased 2 percent, including the anticipated higher selling and administrative costs associated with operating as a standalone company. This resulted in adjusted EBITDA margins of 34 percent, well within VSM's stated target range. The company's net income increased operationally, but the unfavorable comparison to its prior year was primarily due to higher interest rate expense, restructuring and separation costs, and higher tax rates. Consistent with 2016's fundamentals, VSM's advanced materials business continues to show strong volume growth across, memory, logic, and foundry markets.

VSM, having less of a priority focus on large lower margin turnkey projects, had a quarterly performance that was more directly related to its core equipment and installation business. The pick-up from new fabrication plant capacity and expansion for advanced logic and memory allowed delivery systems and services ("DS&S") to deliver strong equipment volumes for the quarter. The company's quarterly margin decrease versus prior years primarily reflects the change in mix of various business lines in its equipment business and associated insulation activity. As such, VSM expects such overall mix to rebalance as it moves through 2017 as new projects are completed. After reorganizing and optimizing its services businesses, VSM will be focused on growth and has gained several pieces of new business at key customers, supported by long-term contracts. With VSM one quarter into 2017, it noted that industry fundamentals are strengthening and its cost to move to an independent company was consistent with its expectations, but also stated there still remains uncertainty in the macroeconomic environment.

VSM maintained its outlook for fiscal 2017, which is based on global GDP in the high 2 percent range, semiconductor millions of square inches of silicon produced growth consistent with external projections, and semiconductor industry wafer equipment spending continuing to remain strong. The company expects sales for fiscal 2017 to be from $0.9 billion to $1.05 billion, a 2 percent to 8 percent increase from fiscal 2016 sales. A continuing improvement in the semiconductor environment and continued growth in new products would push the company toward the higher end of such range. VSM's sales are expected to remain strong throughout 2017 as the semiconductor equipment market continues to improve and it brings on additional capacity. The company also maintained its adjusted EBITDA estimate for fiscal 2017 at $330 million to $350 million as such adjusted EBITDA performance will be determined by market-based product and customer mix and its ability to effectively move from transition services to its own administrative infrastructure. VSM expects to hold its annual meeting in March 2017, where we expect it to initiate an initial dividend as the company previously indicated.

Our initial article on VSM focused on contrasting analyst opinions on VSM. We pointed out that an analyst with a bearish opinion noted that VSM's current "growth prospects" did not yet justify a premium valuation relative to its peers. Such analyst noted further that to justify its higher valuation, VSM needed to show that it can: 1) consistently grow at above industry average rates; 2) increase its margins through improved pricing/mix and cost reduction efforts, and 3) successfully allocate capital from its free cash flow in high return projects. An analyst with a more positive view of VSM, however, had noted that the company's restructuring efforts had already given it industry-leading margins. Prior to VSM's spin off from APD, the company improved its margins by: 1) exiting unprofitable business lines; 2) improving its product mix; and 3) moving a significant portion of its production to Asia. Such positive analyst noted further that VSM would be able to drive revenue/profit growth given its industry leading positions in its advanced materials division and its process materials division, its intellectual property portfolio of patents, its research and development capabilities and its strong relationships with its key customers.

Our opinion on VSM admits that the more "bearish" analyst made valid points as to VSM's need hit to drive higher growth before shareholders are rewarded, but we continue believe that investors should focus more on the "positive" analyst's "glass half full" attitude towards VSM's strengths to drive consistent revenue/earnings growth. We further believe that the multiple insider December 2016 purchases of VSM shares support our thesis to focus on VSM's positive attributes now rather than waiting to see the company prove itself and face diminished investment returns. To remind investors, multiple VSM insiders made significant purchases of the company's shares in December 2016. In particular, G. Bitto (the CFO) purchased 8,000 shares at $24.72 for a total cost of $197,760; J. Croisetiere (Director) purchased 4,000 shares at $24.62 for a total cost of $98,480; S. Ghasemi (Director) purchased 20,000 purchased at $24.66 for a total cost of $493,200; and J. Bowman-Feather (Controller and Principal Accounting Officer) purchased 2,000 shares at $26.70 for a total cost of $53,400. We continue to find these multiple insider purchases closer to VSM's then 52-week high as significant given the positions each insider holds with VSM. With VSM's shares sitting at about $30.50, so far such insiders are up about 20 percent in about 2 months.

Our view

VSM's current priorities are building its culture, capturing profitable growth, continuing to drive productivity across all aspects of the company, and building its infrastructure to operate as a standalone company. Further, the company is focused on meeting its commitments to its customers and shareholders. VSM's performance in fiscal first quarter 2017 aligns with such goals as it had strong revenue growth driven by both legacy and new nodes. The company's strong margins for the quarter were driven by innovation, business mix, and productivity. The company's costs were in line with its expectations for both business and separation activities and they had a very strong cash flow from operations. VSM is well-positioned to benefit from the secular growth trends and a leading position in the semiconductor materials market. In other words, the company has solid growth, high margins, low capital intensity and strong cash flow. Finally, VSM operates as a leading materials and equipment supplier to the semiconductor space, which presents it with meaningful profitable growth opportunities both organic and inorganic. Innovation, a safe, and reliable supply, quality and partnership with its customers are at the core of how VSM creates value for its shareholders.

VSM, as a newly independent company, has the wherewithal to adjust its strategy to achieve consistent above-industry-average growth rates, increase margins through improved pricing/mix and cost reduction effort; and allocate its capital to high return projects. The company, now that is not just a division of a much larger APD, is more clearly able to focus on such objectives to drive above-average industry growth and expand its price to earnings ratio as a result. VSM, as noted above, already achieves industry-leading margins given its prior restructuring efforts. Such margin-improving efforts included exiting unprofitable business lines; improving the company's product mix and moving production to Asia. With VSM achieving improved margins, the company's fortunes will benefit from semiconductor volume growth and its industry leading advanced materials and process materials divisions. In addition, the company's strong research and development programs and its portfolio of patents will add and protect the value of its product offerings and will continue to allow for strong relationships with its key customers. Finally, VSM's growth will also be driven by capital expenditures spending, memory and logic market growth and a shift in semiconductor architecture.

VSM's forward price-to-earnings ratio is about 17.30 based on fiscal 2017 earnings estimates of $1.77, and about 16.10 based on fiscal 2018 earnings estimates of $1.90. Estimates for fiscal 2017 have increased in recent months. We believe that, with overall markets near record highs, an investor could wait for VSM's share price to pull back to a range of about $26.60 to $28.50 to establish a full position. (A forward price-to-earnings ratio in the range of about to 14.00 to 15.00 based on fiscal year 2018 estimates). Notice that our price range tracks closely to where the VSM insiders also made their purchases. We are hesitant of purchasing VSM shares when overall market stand at all time highs and caution potential investors that VSM's shares may retest the price level where insiders recently made their share purchases. Over the long term, however, VSM investors will benefit from share price appreciation, share buybacks and the possibility of a takeover as the company expands and drives revenue/earnings growth from its internal product pipeline and smaller bolt-on acquisitions to fill out its product offerings. (We should note that VSM indicated that it intends to pay out a "nominal" dividend if approved by its board.)

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Disclosure: I am/we are long VSM, APD.

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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