DMC Global Can Be A Boom In The Long Run

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About: DMC Global Inc. (BOOM)
by: Badsha Chowdhury
Summary

BOOM has a robust suite of energy and industrial products.

DynaEnergetics segment gross margin can improve in Q4.

BOOM’s new facility and product lines can improve the top line in the long run.

Completions activity slowdown can pull back BOOM in Q4.

DMC Global’s steady run

DMC Global (BOOM), through its NobelClad and DynaEnergetics segments, serves the energy, industrial and infrastructure markets. Its products are used in perforation of oil and gas wells, and maintenance and retrofit projects at chemical processing, petrochemical processing, oil refining, and aluminum smelting facilities. BOOM’s new facility in Texas will expand the production capacity of its well perforating system. Plus, it is installing two new automated shaped-charge production lines that can triple the U.S. production capacity of advanced perforating charges. While the crude oil price weakness and industry pricing pressure can keep its operating margin down, BOOM has strong drivers to perform robustly over the medium-to-long term. In 2018 so far, DMC Global’s stock price has gone up by 42%, while VanEck Vectors Oil Services ETF (OIH) declined by nearly 31%. OIH represents the oilfield equipment & services (or OFS) industry.

DynaEnergetics keeps going despite headwinds

DMC Global’s DynaEnergetics segment offers perforating products used in drilling oil and gas wells. The products are used in are used in the well completion process, which in turn is highly dependent on oil and gas E&P activity. Exploration activity over the last several years has led to increasingly complex well completion operations. This has increased the demand for advanced perforating products. In Q3, revenues from DynaEnergetics segment increased by a whopping 88% over Q3 2017. When you look at it in comparison to the Q2 2018 revenues, it still grew by 12.6%. This is no mean achievement. As I have discussed in many of my articles on the OFS companies engaged in providing completions services to the upstream operators, the recent completion activity slowdown have caught many unguarded in Q3. According to the EIA’s Drilling Productivity Report, the number of completed wells in the key U.S. shales showed tremendous growth at the beginning of 2018. But since mid-2018, the rate of completions has slowed down considerably. Add to that the upstream companies’ budget exhaustion and the crude oil price weakness in the past three quarters, and you see many of these upstream companies have slowed down their E&P activities. Although this has not necessarily impacted the overall production, the reduced activity level has reflected in a temporary reduction in wells completion activity. In this context, BOOM’s growth is something investors can get encouraged.

Regarding crude oil price and upstream operators’ budget, BOOM’s management commented in the Q3 call,

We expect -- what we're hearing is a general optimism that their budgets are going to be greater in '19 versus '18 and I think in a counterintuitive way, the volatility that we're seeing in the price of oil and gas in this fourth quarter actually helps the land-based unconventional to get a larger share of that budget going forward. So we feel quite confident that it's going to be a good year.

Although DynaEnergetics segment gross margin of 37% in Q3 2018 was a couple of percentages lower than in Q3 2017, it still contributed to BOOM’s consolidated gross margin improvement during this period. This resulted primarily from resulted from a higher proportion of sales from DynaEnergetics and higher average selling prices at DynaEnergetics.

What will drive DynaEnergetics? In this context, readers may be interested in understanding the key advantages of DynaEnergetics’ product offerings. The DynaSelect family of integrated switch-detonators and the DynaStage factory-assembled perforating system are BOOM’s primary products. Traditionally, customers mix and match perforating components from multiple suppliers, and then assembles and wires perforating guns in the field. This leads to errors and higher operating costs. BOOM’s products, by design, reduce misfires significantly, as well as energy companies’ transportation costs and labor costs. Thus, customers’ working capital gets lower and profitability improves.

In Q4, the DynaEnergetics segment gross margin is expected to trend upward. The shipment of two critical components used in the factory-assembled DynaStage system is expected to boost margin by the end of 2018. Investors should also note that the upstream companies’ lack of investment in E&P issues is not something BOOM’s management is overly concerned. As customer refresh budgets in Q1 2019, and takeaway capacity in the Permian increases later next year, DynaEnergetics should benefit from an anticipated strong rebound in activity.

BOOM concentrates in expanding its manufacturing and assembly capacity in North America and Europe. In November, BOOM started an advanced manufacturing, assembly, and administrative facilities on its industrial campus in Blum, Texas. The new facility will expand the production capacity of DynaStage – BOOM’s well perforating system. Also, DynaEnergetics is installing two new automated shaped-charge production lines that can triple the U.S. production capacity of advanced perforating charges. Outside the U.S., BOOM is exploring strategic alternatives for its Russia-based perforating manufacturing and sales operations. These operations are expected to contribute ~ 2% of BOOM’s Q4 revenues.

What are the pitfalls? BOOM cannot entirely shake out the adverse effect of pricing pressure in the OFS industry in Q4. Upstream companies’ budget exhaustion and completions activity slowdown are likely to put pressure on the segment operating margin. But, BOOM can keep the damage limited because it primarily sells its offerings as a system rather than as separate product components as many of its industry peers do. In the Q3 earnings conference call BOOM discussed more than 75% of its segment revenues come from selling it as systems, while the rest comes from selling components.

NobelClad segment faces concerns

In comparison to the steady show in DynaEnergetics, BOOM’s NobelClad segment performance was relatively weak. In Q3, the segment revenue decreased by nearly 2% over Q2, although year-over-year, the revenue growth was 29%. The segment produces clad metal plates which are primarily used in corrosion-resistant industrial processing equipment. Typically, the backlog is a primary means to measure the immediate outlook for BOOM’s NobelClad business. The segment backlog declined 24% in FY2016 over the previous year. It recovered in 2017, but by the end of Q3 2018, has slipped back. Backlog represents unfulfilled purchase orders and commitments at a point in time. A lower backlog points towards lower revenue realization, going forward.

Lawsuit settlement: In November, BOOM settled a lawsuit with GEODynamics. BOOM expects to record a Q4 legal expense of $3 million. GEODynamics had filed a patent infringement lawsuit against BOOM regarding reactive shaped perforation charges.

BOOM’s guidance

BOOM’s management expects Q4 2018 revenues to decline approximately 5% compared to Q3 2018. However, the projected Q4 figure would still be significantly higher (53% up) than the Q4 2017 revenues. The management also expects Q4 2018 EBITDA to close between $13 million to $14 million, up 75% from Q4 2017. BOOM also expects FY2018 diluted EPS in a range of $1.95 to $2.05. This is up from its previous guidance range of $1.80 to $2.00. The revised guidance reflects strong Q3 earnings led by higher sales volumes and lower SG&A expense during the quarter.

BOOM’s debt level is manageable

In the past three quarters of 2018, BOOM generated $6.5 million in cash flow from operations (or CFO). In March 2018, BOOM replaced its old debt by entering into a $75 million syndicated credit agreement, which will expire in 2023. The new credit facility included a $50 million revolver and a $25 million capex facility. In the past three quarters of 2018, BOOM has spent $26.5 million in capex. It also pays a quarterly cash dividend of $0.02 per share, which means a forward annual dividend yield of 0.22%. With the available liquidity (cash balance and revolving credit facility), and at the current cash flow generation run rate plus no debt repayment obligations in near-term, BOOM’s balance sheet looks comfortably placed. But the company needs to improve its cash flows significantly in the medium-to-long term to meet all its financial obligations.

Stable management: Kevin T. Longe has been serving BOOM’s CEO since 2013. Michael L. Kuta has been its CFO since 2014. David Aldous was appointed as the Chairman of the board in May 2018.

What does BOOM’s relative valuation say?

BOOM is currently trading at an EV-to-adjusted EBITDA multiple of ~12x. Based on sell-side analysts’ estimates in the next four quarters, as pulled from Thomson Reuters, BOOM’s forward EV/EBITDA multiple is lower, which implies higher EBITDA. BOOM is currently trading at a steep discount to its past six-year average of 46.0x.

BOOM’s EBITDA is expected to improve in line with the rise in the peers’ average in the next four quarters, which typically reflects in at-par current EV/EBITDA multiple compared to the peers. BOOM’s TTM EV/EBITDA multiple is, however, higher than its peers’ (GRC, HURC, and OIS) average of 10.4x.

Analysts’ rating on BOOM

According to data provided by Seeking Alpha, five sell-side analysts rated BOOM a “buy” in December, while none of the sell-side analysts rated BOOM a “hold” or a “sell”. The analysts’ consensus target price for BOOM is $53, which at BOOM’s current price yields ~49% returns.

What’s the take on BOOM?

DMC Global serves a niche sector of the energy, industrial and infrastructure markets. DMC Global has a strong demand for perforating products in the oil and gas wells. BOOM is strengthening its U.S. operations by commencing a new manufacturing and assembly facility while consolidating its operations in Europe and Russia. Its DynaSelect and DynaStage family of products are the key differentiators, which are expected to keep BOOM’s top line and bottom-line steady. BOOM’s balance sheet is also strong and has no near-term debt repayment after the refinancing. Although the current weakness in the energy market can put pressure on BOOM’s short-term growth and margin, BOOM can be a good long-run investment at a lower stock price level.

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.