- Casket volumes in the memorialization segment have been very strong, resulting in strong operating leverage.
- As pandemic restrictions ease, topline dynamics of the Brands and Industrial technologies division could pick up.
- Management has managed to tone down leverage impressively even as the operating cash flow momentum remains strong.
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In Q3-20, I had written in detail about Matthews International Corporation (NASDAQ:MATW) - a diversified company with multiple drivers. You can glean some insight into my initial bullish stance on the stock here. While some parts of its business still continue to be hampered by the pandemic-related headwinds, generally, the company has coped well, showcasing strength in some core areas. This has been reflected in the price of the stock which is up ~67% since the publication of my previous article. In this article, I will explore some of MATW's dominant themes and shed some insight into the company's progress over the last few months.
Memorialization division performance key to improvement in Group EBITDA
During cyclical downswings, one often hears about the merits and qualities of "counter-cyclical" businesses, and invariably these stocks tend to get a lot of mileage then. MATW has a division that wouldn't normally be termed as "counter-cyclical," but it has benefited immensely from the current health pandemic on account of increased COVID-19 related deaths. Under this division, produces and distributes caskets and a whole host of memorialization products used in cemeteries, funeral homes, and crematories. This is a major contributor to the overall business with a 41% share of group revenue and the EBITDA margins of this division are group-leading as well (24% in Q1-21).
In the recently concluded December quarter (Q1-21), the memorialization segment sales saw revenue grow by ~19% driven mainly by increased sales of caskets due to pandemic-related deaths. In addition to this solid volume, the company has been attempting to drive through various productivity initiatives. The combination of these two factors resulted in significant operating leverage with the adjusted EBITDA growing by an impressive 46% annual growth, and adjusted EBITDA margins for this division coming in at an impressive 24%, a gain of 450bps YoY. Due to the strong weight of this division in the overall sales mix, group EBITDA too benefited, growing by 37%. Back in August 2020, I had suggested that this was likely to happen.
That said, it's not as though all parts of this division are performing at full tilt. While casket sales have been good, the sales of cemetery memorial products continue to be sub-par, as the local stay-at-home orders have meant that many families are unable to access cemeteries and arrange for memorials. Ostensibly, as the vaccine drive gains pace, one is likely to see these restrictions loosen and we could see some of these deferred business opportunities come back. Conversely, as herd immunity gains pace, we may see the pace of deaths reduce and this could stymie the ongoing momentum on casket sales.
SGK Brands division - Topline challenges, but cost reduction programs paying off
This vertical continues to be affected by COVID-19 related pressures across various end markets. For instance, management highlighted challenges in their retail, merchandising, and private label businesses that have been hampered by weak demand. There also have been challenges in selling cylinders, surfaces, and engineering products within this segment as demand conditions remain sub par. In effect, sales from this division were down 4% annually.
Going forward, as things normalize, one would expect these businesses to start picking up. Besides single-use plastic regulations in Europe which require new labeling on cigarettes and other packaging could likely see MATW's tobacco-related business pick up. The management also highlighted the attractive prospects of their engineered products for the energy storage business which they expect to flourish in the coming year. Do note that this energy storage endeavor is something of a recent phenomenon for them, having received their first significant order only during the September 2019 quarter. This general low base means you could potentially see high growth rates in this vertical, more so at a time when the prospects of energy in 2021 look particularly bright.
Even as this division's topline has remained subdued, I've been encouraged by how effectively the division has grown its margins from 10.7% a year ago to 12.7% in Q1-21. This was mainly driven by savings from the company's cost reduction program. There also were some benefits from lower travel-related expenses but I don't believe this will be a sustainable tailwind as the lost business comes back.
Industrial technologies - sales subdued but order backlog has picked up
The other division which continued to see a muted response on account of generally sub-par industry conditions was the Industrial technologies division. On an annual basis, sales were relatively flat at $35.2m. While sales may have been flat, what's important to note is that the warehouse automation order requests doubled on an annual basis highlighting the pent-up demand. The issue here has been a lack of access to the clients' job sites, to complete orders, as restrictions still persist due to the pandemic. Ostensibly in the coming quarters, we can expect this strong order flow to translate into top-line momentum.
Leverage management and cash performance
I've highlighted previously the steps that the MATW management has taken to become less financially geared, and progress with this aspect has continued for yet another quarter. In the December quarter, resilient operating income combined with strong working capital management saw the operating cash flow surge by almost 6x from $5.4m a year ago to $35.3m currently! What's noteworthy is that this impressive cash performance has come through during the company's traditionally slowest quarter (on account of the holiday season).
On account of these impressive cash flow dynamics, the company was able to tone down its outstanding debt by a further $10m. In effect during the whole of 2020, the company has managed to bring down its gross debt by a significant figure of $142m. Also, consider that while paying down their debt they continued to pay quarterly dividends, which have now grown for the last 26 years. The leverage ratio declined sequentially from 3.9x to 3.6x and brings this closer to the company's long-term desire is to get to 3x net debt. Going forward, while business momentum picks up, it may be unrealistic to expect the same exemplary operating cash flow performance.
Valuations and conclusion
Current valuations may not be cheap but they are not prohibitive either. When I had recommended the stock back in August, the stock had been trading at a discount to its five-year average, on a forward P/E basis, forward EV/EBITDA basis, and price/cash flow basis. Currently, the discount factor has ebbed on the P/E and EV/EBITDA basis with the stock now trading in line with its long-run average of 12.6x and 9.3x respectively. However as highlighted in this article, I think the market is still underappreciating the strong cash dynamics seen over the last few quarters and this is reflected in a price to cash flow multiple of only 5.57x, almost a 50% discount to the long-term average of 10x.
To sum up, I continue to be optimistic about the prospects of MATW. So far under weak economic conditions, it has managed to keep costs under control and engender strong EBITDA and cash flow performance. Of course, pandemic-induced deaths have been instrumental in aiding volumes in the memorialization division, but the other two divisions haven't been as sturdy on account of the pandemic-related headwinds. It now looks as though these headwinds could be abating. As I wrote in The Lead-Lag Report this week, cyclical and industrial plays have picked up steam in recent weeks on account of optimism over the stimulus and vaccines, coupled with a broader rotation out of the growth sectors. This should bode well for the likes of MATW that have strong industrial end-market exposure.
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