NewMarket Corporation — Q2 2016 Form 10-Q
Business and period: NewMarket operates primarily in petroleum additives, including lubricant and fuel additives; “All other” includes the tetraethyl lead business and certain Ethyl contracted manufacturing and services. This unaudited report covers the quarter and six months ended June 30, 2016, compared with the corresponding 2015 periods.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $521.8 million | $560.7 million | $1,031.7 million | $1,120.3 million |
| Gross profit | $178.4 million | $169.7 million | $354.0 million | $351.0 million |
| Operating profit | $97.3 million | $88.9 million | $192.7 million | $188.7 million |
| Net income | $64.4 million | $58.7 million | $126.3 million | $122.7 million |
| Diluted EPS | $5.43 | $4.72 | $10.65 | $9.86 |
| Cash dividends declared per share | $1.60 | $1.40 | $3.20 | $2.80 |
Margins: Gross margin was approximately 34.2% in Q2 2016 versus 30.3% in Q2 2015, and 34.3% for the first six months versus 31.3%. Petroleum additives operating margin was 19.9% in both 2016 periods, compared with 16.9% for Q2 2015 and 17.9% for the 2015 six-month period.
Segment revenue: Petroleum additives revenue was $516.1 million in Q2 (down 7.4%) and $1,022.3 million for six months (down 8.1%). Lubricant additives revenue was $432.2 million and $851.0 million, respectively; fuel additives revenue was $83.9 million and $171.2 million. Petroleum additives operating profit increased to $102.5 million for Q2 and $202.9 million for six months. “All other” operating profit was $1.4 million for Q2 and $1.6 million for six months.
Cash, debt and liquidity
- Operating cash flow was $188.0 million for the first six months, versus $123.2 million in 2015. Capital expenditures were $64.3 million, compared with $50.0 million.
- Cash and cash equivalents were $158.1 million at June 30, 2016, up $64.7 million from year-end; approximately $151.2 million was held by foreign subsidiaries. Management said cash from operations and available borrowing were expected to cover operating needs and planned capital expenditures for at least 12 months.
- Total long-term debt was $521.3 million, up from $490.9 million at December 31, 2015. It included $350 million principal amount of 4.10% senior notes due 2022, $170 million drawn on the $650 million revolving facility, and a $5.1 million capital lease obligation. Unused revolver capacity was $476.3 million.
- The current ratio was 3.09 to 1. The company reported compliance with debt covenants; leverage ratio was 1.32 and interest coverage ratio was 23.33 at June 30. The revolving facility matures October 2019.
- Cash dividends paid were $37.9 million and share repurchases were $35.8 million in the first half; all repurchases occurred in Q1. Shares outstanding declined to 11,848,384 from 11,948,446 at year-end.
Changes and management commentary
Revenue declined 6.9% in Q2 and 7.9% for the first half, primarily due to lower selling prices and lower shipments. Petroleum additives shipments fell approximately 1.5% in Q2 and 2.4% for six months; lower selling prices were also a significant factor. In contrast, lower raw-material costs were the principal driver of improved gross profit and petroleum additives operating profit, more than offsetting unfavorable selling-price and volume effects. Higher average debt contributed to increased interest expense. The effective tax rate declined to 30.1% for Q2 and 30.2% for six months, including the benefit of the R&D tax credit.
Management expects solid petroleum additives performance in 2016 and estimates long-term industry shipment-demand growth of 1% to 2% annually, with an aim to outgrow the industry. The company stated a goal of a 10% annual shareholder return over any five-year period, defined as EPS growth plus dividends, while noting it may not achieve that return every year. Capital spending in 2016 is expected to exceed 2015’s $126 million, including spending on the Singapore facility and global manufacturing and R&D infrastructure. Phase one of the Singapore facility was complete; phase two was expected to be completed in 2018 and more than double the investment there. No specific EPS or revenue guidance was provided.
Risks, contingencies and unusual items
- Environmental remediation, dismantling and decontamination accruals were approximately $16 million at June 30, 2016. Accrued costs for the Louisiana and Texas sites totaled about $10 million on a discounted basis; unexpected future environmental costs could materially affect results, financial position or cash flows.
- The company described ongoing environmental and other legal matters, including an EPA TSCA inspection of Afton and Ethyl and a DOJ review concerning certain foreign business activities and historical domestic conduct. Management did not expect the matters to have a material adverse effect; no provision was recorded for the DOJ review.
- The interest-rate swap was not hedge-accounted; its fair-value changes flow through earnings. The swap liability was $24.8 million at June 30, and $30 million of cash collateral was posted. Q2 and six-month 2016 swap losses were $1.5 million and $5.4 million, respectively.
- Most foreign cash was associated with earnings designated as indefinitely reinvested; repatriation of those earnings could result in incremental U.S. tax. Foreign-exchange movements, raw-material availability and prices, customer concentration, facility disruptions, competition, regulation and other forward-looking risks were also identified.
- The July 15, 2016 amendment to the revolver permits certain foreign subsidiaries to borrow under the facility. Management said it incurred no additional financing fees.
Important facts for investors to verify
- Whether lower prices and shipment volumes persist, and whether raw-material cost benefits continue to support margins.
- Execution, timing and spending for the Singapore expansion and other capital projects, alongside management’s expectation that 2016 capital spending will exceed 2015.
- Debt, cash availability and covenant headroom, including the concentration of cash in foreign subsidiaries and potential tax consequences of repatriation.
- Developments in environmental remediation, the TSCA inspection and DOJ review, and whether related accruals or exposures change.
- Future swap fair-value movements and their impact on reported earnings.