Is It Time To Buy W.R. Grace?

| About: W.R. Grace (GRA)

W.R. Grace & Company (GRA) is an old-line specialty chemical company with two operating segments: Grace Division that provides specialty chemicals, materials and formulation technologies, and Grace Construction Products that produces specialty construction materials, systems and services. In 2001, W.R. Grace and its U.S. subsidiaries entered voluntary bankruptcy under Chapter 11. Bankruptcy was driven by the company's asbestos-related liabilities. Grace's Joint Plan of Reorganization is proceeds through the process of court approval and claimant objections. The timing of the company's emergence from bankruptcy remains uncertain.

In July, Grace provided guidance for 2012. They anticipate sales in the range of $3.1 billion to $3.2 billion, reflecting higher sales volume and price increases, offset by lower raw material costs and currency conversion costs. They expect gross margins in the 35%-37% range with lower raw material costs. The company continues to project an "atypical" quarterly earnings pattern for the year and now expects the third quarter to be weaker than the second and fourth quarters.

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In F2Q12, total revenues were essentially flat, at $826.7 million, compared to $826.4 million in F2Q11. Geographically, there were improvements. Emerging markets account for about one third of Grace's sales. In the second quarter, sales from emerging markets grew 13%. Strong sales in Asia, Latin America and the Middle East helped the construction segment grow by 6%. Revenues at the Grace Division, which contributes the largest share to total revenues, fell 2%. Sequentially, revenues grew about 10% from the first quarter.

For the trailing twelve month period ending 2Q12, revenues grew by 12.9% to $3,270.9 billion from $2,897.2 billion year-over-year. Grace provides guidance for F12 bringing anticipated revenues down to the $3.1 billion to $3.2 billion level. The consensus revenue forecast reported by Thomson Reuters is $3,154.85 million.


In the second quarter, net income fell about 9% to $69.3 million ($0.90/share) from the prior year net of $75.8 million ($1.00). Sequentially, net income grew 14% to $69.3 million. Year-over-year, EPS grew by 15.7% to $3.54 from $3.06. According to Thomson Reuters I/B/E/S, analysts expected EPS of $1.11 on revenue of $816.2 million. For F12, analysts provide EPS estimates ranging fro $4.05 to $4.25. For F13, the expectation is that EPS will range from $4.05 to $4.75.


Gross margin for 2Q12 came in at about 37% and compares with 36.2% for the trailing month months and 36.1% in F11. Operating margins at 12.8% for the quarter are in line with the 12.9% for the trailing twelve months and better than the operating margin of 11.9% the company saw for F11. The pattern repeats itself with net margins of 8.4% in2Q12 and 8.2% TTM.

Balance Sheet

Inventory decreased this quarter to $317 million as compared to $358.5 million in the first quarter and $329.1 million at the end of F11. Inventory as a percentage of sales is 33.3%, 47.5% and 39.9%, respectively. Cash and short term investments totaled $1,111.4 million at the end of the quarter and long-term debt totaled $23.5 million. For the TTM period, the company generated $404.4 million in cash from operations and spent $145.7 million on Capex. Grace does not pay a dividend but did increase the average number of shares outstanding by ~1.5%.


The company has current and expected costs related to the bankruptcy proceeding. For the first six months of F12, Grace expended $30.4 million on these expenses. Grace is liable for additional expenses related to the emergence from Chapter 11, various defined benefit pension obligations and expenditures for asbestos-related environmental remediation efforts.


W.R. Grace appears close to emerging from bankruptcy. On metrics such as EV/EBITDA and EV/Sales, it appears to be undervalued. The forward PE is in-line with the market's. The company is profitable and generates free cash flow. Long-term debt is not significant when compared to free cash flow. However, pension and other bankruptcy liabilities, not presented here, must also be considered.

Grace is outside our risk boundaries and, therefore, as an individual investor, I would not be comfortable in owning GRA.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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