It sure looks like a good time for Quaker Chemical Corp. (KWR), a maker of specialty chemical products, whose stock has been hitting fresh highs, unfazed by headwinds from soaring raw material costs. The stock has nearly doubled from its January low of $16 and currently trades near its 52-week high of $33.82. The chemical company, which serves steel, automotive, mining, aerospace, tube and pipe, coatings, and construction materials industries, is not related to any other Quaker company. Quaker Oats Company - a food conglomerate, Quaker State Company - a manufacturer of engine oils and Quaker Chemical Company - a manufacturer of chemical products for industrial use, are among the other companies carrying 'Quaker' in their name.
In stark contrast to the benchmark Standard & Poor's 500, which has lost nearly 12% over the past twelve months, Quaker Chemical is up an impressive 50% during the same time frame and remains poised for further growth.
Profile
Based in Conshohocken, Pennsylvania, Quaker manufactures rolling lubricants, corrosion preventives, metal finishing compounds, machining and grinding compounds, forming compounds, hydraulic fluids, chemical milling maskants and construction products. Far from being just a producer of chemical specialty products, Quaker also provides chemical management services for various heavy industrial and manufacturing applications with significant sales to the steel and automotive industries.
Quaker operates under three segments - (a) metalworking process chemicals segment that produces lubricants for various heavy industrial and manufacturing applications; (b) coatings segment that produces temporary and permanent coatings for metal and concrete products and chemical milling maskants; and (c) other chemical products segment.
Earnings scorecard - A good propellant
Though Quaker's earnings fell 39% in 2004 due to higher raw material and selling, general and administrative costs and plunged 81% in 2005 burdened by higher raw material costs and restructuring costs, the restructuring plan initiated during 2004 and 2005 appears to have put the business back onto a growth path.
From 2005 through 2007, the company's earnings have grown at a compounded annual growth rate or CAGR of 109%, while net sales rose at a nearly 9% CAGR. Quaker's fiscal year ends on December 31.
In fiscal 2007, net income increased to $15.5 million or $1.53 per share from $11.7 million or $1.18 per share in 2006, driven by 18.5% net sales growth. Helped by higher volumes, particularly in China and Europe, and increased selling prices, net sales for 2007 climbed to $545.6 million from $460.5 million a year before.
Despite eye-popping raw material costs, Quaker's net income grew to $4.32 million in the recent second quarter ended June 30 from $4.15 million in the comparable quarter a year-ago, helped by considerable leverage in Selling, General and Administrative or SG&A expenses. On a per share basis, earnings for the quarter were $0.41, unchanged from last year.
Factored into the second quarter results of 2008 is a charge of approximately $1.9 million of incremental expense, or about $0.12 per share, related to the upcoming retirement of the company's CEO. Ronald J. Naples, Chairman and CEO of Quaker will leave the office of CEO, effective October 3, 2008.
Quarterly net sales rose to $158.2 million from $137.6 million in the prior year quarter. SG&A as a percent of sales was 23.5% in the second quarter of 2008, compared to 25.7% in the year-ago quarter.
Overseas foray - Well formulated
Quaker's core customer sectors include steel, auto, and metalworking that make use of its specialty chemical products. In fiscal 2007, the company's foreign earnings before income tax rose to $23.99 million from $18.04 million a year before. Excluding income tax, domestic operations contributed to a loss of $1.26 million, compared to earnings of $395 thousand in 2006.
In a recent filing, the company said it has over a 65% share in steel and has succeeded in establishing solid relationships in metalworking. Quaker's foray into booming markets like China, Brazil, India and Russia is paying off, according to the company.
In China, Quaker's revenues rose three-fold in 2007, compared to 2004, reflecting increased demand in the steel chemicals market. Fueled by fast urbanization and many large infrastructure projects, China's consumption of crude steel in 2008 is expected to grow about 11%, reflecting an increase of 44 to 50 million tons, according to the China Iron and Steel Association. Increased demand for steel triggers the increasing need for specialty chemicals, which bodes well for Quaker.
In its 2007 Annual Report, Quaker said that sales by its joint venture in India increased dramatically over the past 10 years. In 1997, the company acquired a 55% interest in a joint venture with its Indian licensee, Asianol Lubricants Ltd., to manufacture lubricants for the cold rolling of steel and other products for the steel industry in India. Looking ahead, the company believes that it is well positioned to take advantage of the recent and future economic growth in India.
Currency translation - The perfect math
A significant part of Quaker's revenues and earnings come from outside the U.S., namely Asia/Pacific, Europe and South America. In 2007, foreign exchange rate translation increased revenues by about 5%, compared to 2006. The average euro to U.S. dollar exchange rate was 1.37 in 2007, compared to 1.26 in 2006, and the average Brazilian real exchange rate was 0.52 in 2007, compared to 0.46 in 2006. As the U.S. dollar weakens against foreign currencies, the translation of the foreign currencies into dollar equivalents results in increased consolidated net revenues, operating expenses and net income.
Business model - A balanced equation
The company's business policy of establishing and maintaining long-term relationships with its customers is also one of the reasons for its consistent growth and profitability on a global basis.
The chemical management services or CMS offered by Quaker enable its customers to achieve the maximum value by using chemical products in the most effective way. Quaker has 76 CMS sites, mostly with global automakers. In 2006-07, the company retained every CMS contract up for renewal in North America.
In 2007, Quaker continued building its CMS presence in China and Brazil and began its first CMS relationship in Mexico. Apart from the automaker sector, the company is also continuing to expand its CMS services into the steel sector with additional sites in the U.S. During 2007, CMS accounted for 12.2% of consolidated revenues, up from 10.3% in 2006.
No overly dependence on whale customers
Quaker does not depend entirely on some big clients for revenue. In 2007, only about 29% of the company's consolidated net sales were made up by its five big clients. Arcelor- Mittal Group, which is Quaker's largest customer accounted for about 10% of consolidated net sales. Relying on a few big customers could spell trouble, as losing one of them would ruin the business.
Dividend - A durable coating
The company offers investors an opportunity for both equity appreciation and dividend returns. For shareholders of Quaker, the year 2007 marked the 35th consecutive year of dividends. The dividends paid in 2007 totaled $0.86 per share, up from $0.705 per share in 1997. Early this year, the company boosted its quarterly dividend to $0.23 per share from $0.215 per share. Quaker offers an annual dividend yield of 2.80%, compared to the sector average of 2.81% and the industry average of 1.57%.
Valuation - No crystal ball
While Quaker's trailing P/E ratio of 18.62 is higher than the industry average of 16.11, its forward P/E ratio is 14.59, which is lower than the industry average.
Balance sheet - A no spill
Quaker's operating cash flow at the end of the recent second quarter ended June 30 improved to $14.3 million from a negative operating cash flow of $6.19 million in the preceding quarter, thanks to the considerable leverage in SG&A expenses. The company expects to improve its cash flow by approximately $3 million per year due primarily to lower manufacturing costs.
The company's net debt-to-total-capital ratio has decreased to 28% from 32% at December 31, 2007, primarily on strong second quarter 2008 operating cash flow.
Though Quaker has a decent gross margin of 29.74%, which is higher than the industry average of 27.76% as well as its peer Lubrizol Corp.'s (LZ) 23.63%, its operating margin is below the industry average.
Quaker's operating margin is 5.34%, compared to Lubrizol's 9.66% and the industry average of 6.65%, implying that Quaker's overhead expenses are higher than Lubrizol as well as the industry average.
The company's current ratio, a measure of liquidity for the most recent quarter is 2.22:1, implying that the company has over twice as many current assets as current liabilities.
Conclusion
Favorable currency translation effects, Quaker's unique business model, a strong balance sheet, overseas expansion and a valuation lower than the expected earnings growth are some of the positive catalysts that could fuel the stock price higher. With that said, however, Quaker, which uses over 1,000 raw materials, including mineral oils, organic and inorganic compounds, faces headwinds from higher raw material costs.
For comments and feedback: editorial@rttnews.com