Quaker Chemical: Slowly Developing Some Chemistry

Feb. 28, 2022 10:35 PM ETQuaker Chemical Corporation (KWR)

Summary

  • Quaker Chemical Corp has seen solid results in 2021 following the Houghton deal announced in 2019.
  • The timing of that deal, just ahead of the pandemic, was a bit unfortunate of course.
  • After a very strong first half of 2021, it was the second half which was quite soft, amidst raging inflation.
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Quaker Chemical Corp (NYSE:KWR) has been struggling a bit as of recent, enough of a reason to establish a view on Quaker. For that, we have to go all the way back to 2019 when Quaker Chemical announced that it was combining its operations with Houghton International.

The timing, just ahead of the pandemic, was a bit unfortunate and while the deal was set to bring the real benefits in 2021, achievements were held back on the back of raging inflation and supply chain issues.

Back to 2019

Quaker and Houghton announced that they would combine their operations back in 2019. Both firms were about equally large and profitable at the time in a deal set to create a business with just over $1.6 billion in sales and roughly a quarter of a billion in EBITDA, as that number should rise towards the $300 million mark with synergies seen as high as $60 million per annum!

Shares of the company traded around the $170 mark at the time and as the deal was quite large (in relative terms of course) as the funding took place through a combination of debt and equity, leaving the company saddled with debt equal to 3.4 times EBITDA.

The deal created a global leader in industrial process fluids, including some 15,000 customers across the globe, with more than 4,000 workers operating in numerous manufacturing facilities across the globe. It is this added diversification which came in handy amidst the pandemic.

In terms of geographic coverage, Quaker is quite diversified across all three major geographic regions, with 50% of sales tied to metalworking, 30% to primary metals and 20% related to global specialty businesses. It is this great diversification which was welcomed as the merger resulted in quite some leverage being apparent on the balance sheet, causing shares to fall from $170 at the time of the deal announcement to $100 during the outbreak of the pandemic.

2020 - First Year Of Operations

The year 2020 was the first year of operations for the combined company which is unfortunate timing, to say the least. Nonetheless, shares recovered quickly and rallied towards the $200 mark again in the summer as the economy rebounded, while rallying towards the $250 mark by year-end.

Early in 2021, it became apparent that 2020 sales rose sharply to $1.42 billion, yet these results came in far below the pro forma results indicated at the time of the deal, with organic sales down 11%. The company managed to post adjusted EBITDA of $222 million while net debt stood at $706 million, translating into a 3.2 times leverage ratio. Adjusted earnings came in at $4.78 per share, with quite some adjustments taking place, down a full dollar from the year before.

Of course, the results were improving throughout the year and this momentum as well as anticipation of further realization of synergies made that the company already provided a guidance for 2021. This called for EBITDA to rise by more than 20%, indicating a minimum of $266 million.

That $44 million in incremental earnings power is very significant, equal to $2.50 per share ahead of taxes, so likely adding more than $2 to earnings per share in 2021! With earnings trending at nearly $7 per share, the valuations were still somewhat demanding, certainly as shares rallied to the $250 mark at the arrival of 2021. Based on earnings power of around $7 per share seen in 2021, valuations were rather demanding at 35 times forward earnings, accompanied by quite some leverage of course.

2021 - Stagnation

Shares of the company even rallied to the $300 mark in February, but ever since have fallen back to the $250 mark in the summer as the company has actually seen solid results for the first half of the year, actually far ahead of my $7 per share estimate. After all, adjusted earnings already topped $3.39 per share in the first half of the year, making an $8 per share run rate perhaps more reasonable to work with.

Shares still traded at $230 by the end of the year as inflation was arguably having an impact, with third quarter results being a bit less convincing. Since the start of the year, shares have fallen further, in fact they have now fallen to just $185 per share, actually largely in line with the price at the time of the Houghton deal announcement in 2019.

In February, the company actually announced its 2021 results with revenues of $1.76 billion being up 24% on the year before. Fourth quarter revenues were up 14%, yet pricing was very strong with volumes actually down, on the back of inflation and supply chain issues. The problem is that the $8 per share run rate, based on the first half of the year, was actually not within reach because of inflationary pressures.

In fact, adjusted earnings for the year only came in at $6.85 per share, as in fact the fourth quarter earnings only came in at $1.29 per share, down slightly from the year before amidst these headwinds. For the year, the $274 million EBITDA number was largely in line with the original guidance as net debt of $728 million works down to a more manageable 2.6 times leverage ratio.

What Now?

For 2022, the company is hopeful that it can see margins recover again after a difficult second half of the year, when supply issues and material cost inflation are severely impacting results, but as some of these factors might alleviate a bit and pricing power is strong, at least margin stabilization should be achievable. That of course requires a solution on the geographical front as well.

While the reduced earnings power is not that compelling, shares have been reset quite a bit, from albeit far too high valuations at the start of 2021. Shares have fallen nearly $100 to $185 now, which results in a 26 times multiple based on $7 per share in earnings power, or 23 times if we see earnings come in a dollar higher.

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