Investors likely came away encouraged from the latest investor day event by Koppers Holdings (NYSE:KOP), a leading integrated producer of carbon compounds and commercial wood treatment products, with the company outlining some compelling earnings growth opportunities across new products and markets, mix improvement, and network optimization. Additionally, I also see incremental upside opportunities in the operating performance should management successfully execute on its M&A-led expansion into transformative adjacencies and if the infrastructure package passes.
In the meantime, KOP shares trade at an attractive c. 6x fiscal 2022 EV/EBITDA, leaving plenty of room for multiple expansion as it inches closer toward c. $300 million in medium-term EBITDA generation.
KOP has come a long way in transforming its core business into a more predictable one – per CEO Ball, the CMC ("Carbon Materials and Chemicals") business would have posted massive losses through the COVID-19 period under its old structure. Instead, KOP has been able to deliver an impressive c. $45 million of EBITDA (implying c. 12% margin) in fiscal 2020 despite the disruptions – a testament to its many years of restructuring.
However, the investor day targets indicate the opportunity through fiscal 2025 is shifting toward expansion, with KOP now in a position to go on the offensive. Specifically, KOP plans to leverage numerous projects to improve its EBITDA margin, with its medium-term margin profile targeted at 15-17% (up from c. 13% in fiscal 2020) on the path to generating $300 million in run-rate EBITDA.
I view the headline EBITDA target as well within reach - KOP is already on track for an impressive seventh consecutive year of EBITDA growth. And cash flow generation has also been solid, enabling debt paydown following the acquisitions of Osmose and Cox and clearing the path toward further M&A as the company looks to build on its key growth platforms in wood treatment.
Also worth noting is that KOP management has not included the passage of a US infrastructure bill in its base case c. $300 million outlook – as more than half of its business is exposed to infrastructure, this could mean significant incremental upside to earnings ahead. Additionally, I also think underlying market growth could enhance the earnings potential of KOP's initiatives, presenting further upside to the medium-term EBITDA target.
KOP's reorganization efforts have aligned operations with strategy, and from here, KOP is focusing on improving execution from cost and growth standpoints. I see plenty of earnings growth potential should management execute well, with the company now the only vertically integrated plater in wood treatment and chemical manufacturing. Divestments are also likely to be a key contributor - last year, KOP exited its Chinese JV (KJCC), reducing its country risk and yielding c. $55 million in cash. Notably, the move follows similar divestments across its defined UK pension to an insurance company, along with the downsizing of its CMC footprint to 3 facilities and the consolidation of its CMC terminal network.
Source: Koppers Investor Day Presentation Slides
Looking ahead, I see vertical integration as a key advantage – it not only helps to reduce supply chain risk relative to peers by shortening its supply chain lead times but also diversifies its revenue base by creating incremental value paths in residential lumber and other end markets. Vertical integration is also guided to add new growth drivers in areas like residential lumber, patented products, and carbon materials end markets. With competitors lacking these growth opportunities due to their fragmented supply chains, KOP is well-positioned to move up the value chain in areas like enhanced carbon products, underpinning the medium-term margin expansion path.
Encouragingly, KOP is also targeting cumulative growth capex of c. $275m over the fiscal 2021-2025 period and c. $150 million of FCF generation. But while growth initiatives remain the main priority for cash deployment, the company is also evaluating tuck-in opportunities that could improve current offerings and continues to explore longer-term transformative opportunities like lithium-ion batteries and EVs as well.
There also remains room for capital return and deleveraging – assuming KOP spends c. 50% of available cash on capex (i.e., roughly half in growth capex) over the 2021-2025 period, the remainder is slated to be spent on repurchases, dividends, and debt reduction in the absence of M&A opportunities. Progress on the debt reduction is key – thus far, KOP is on track to reduce its net leverage ratio to 3.1x by end-2021 (slightly above its 2-3x goal but well below the c. 5x in fiscal 2018), and positive progress here could free up even more balance sheet flexibility for M&A. As KOP is also guiding toward additional borrowing capacity of $250-350 million at its target leverage range of 2-3x by fiscal 2025, I see positive implications for the credit rating ahead.
Source: Koppers Investor Day Presentation Slides
On balance, KOP's continued steps to improve underlying profitability, including network optimization and efficiency improvements in its key business segments, point toward plenty of earnings upside ahead. Meanwhile, the debt paydown story at KOP is progressing well, with the company on track to reach 3.1x net debt-to-EBITDA by end-2021. Coupled with the potential for the incremental infrastructure spending benefits, there remains plenty of room for more consistent share price accretion over the longer term as the valuation multiple re-rates closer in line with key peer Stella Jones (OTCPK:STLJF).
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