NewMarket Corporation — Q3 2018 Form 10-Q
Business and period: NewMarket manufactures and sells petroleum additives globally; its main segment is petroleum additives, with a smaller “all other” category that includes TEL operations and certain contracted manufacturing and services. This unaudited report covers the quarter and nine months ended September 30, 2018, compared with the same 2017 periods. Amounts below are in millions of dollars unless stated otherwise.
Financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $563.2 | $548.4 | $1,751.4 | $1,638.4 |
| Gross profit | $140.9 | $158.9 | $443.5 | $491.2 |
| Operating profit | $68.1 | $78.7 | $216.9 | $256.0 |
| Net income | $58.5 | $59.8 | $171.9 | $186.4 |
| Diluted EPS | $5.12 | $5.04 | $14.78 | $15.73 |
| Cash dividends declared per share | $1.75 | $1.75 | $5.25 | $5.25 |
- Margins: Gross margin was 25.0% in Q3 and 25.3% year to date, versus 29.0% and 30.0%, respectively, in 2017. Operating margin was 12.1% and 12.4%, versus 14.3% and 15.6%; net margin was 10.4% and 9.8%, versus 10.9% and 11.4%.
- Cash flow: Nine-month operating cash flow was $101.1, down from $177.8. Working capital used $69.2 and pension/postretirement contributions used $61.9. Investing cash outflow was $40.6, including $55.1 of capital expenditures, partly offset by asset-sale proceeds. Financing cash inflow was $6.0, including $215.6 of net revolver borrowings, offset in part by $60.8 of dividends and $148.6 of share repurchases.
- Balance sheet and liquidity: Cash was $147.9 at September 30, 2018, including $142.0 held by foreign subsidiaries. Long-term debt was $818.5, up from $602.9 at year-end 2017; shareholders’ equity was $564.1. The company reported $631.7 of unused capacity on its $850 million revolver, a 3.28 current ratio, and covenant leverage and interest coverage ratios of 2.18 and 12.97, respectively. It reported compliance with debt covenants.
Changes and operating drivers
- Sales rose 2.7% in Q3 and 6.9% for the first nine months. Petroleum additives sales increased 2.6% and 6.9%, respectively. Nine-month sales growth reflected higher selling prices, favorable currency effects, and shipment impact; Q3 petroleum-additives shipment volume declined 3.6%, while nine-month volume declined 0.3%.
- Petroleum additives operating profit fell $8.4 in Q3 and $39.3 year to date. Segment operating margin was 13.5% in Q3 and 13.3% year to date, versus 15.4% and 16.6% in 2017. Management attributed pressure principally to higher raw-material and conversion costs and unfavorable currency translation; selling-price increases partly offset cost pressure, with a lag before they improve margins.
- Interest expense increased to $7.8 in Q3 and $18.5 year to date, primarily reflecting higher average debt. Lower effective tax rates contributed to lower tax expense: 14.4% in Q3 and 21.6% year to date, versus 22.4% and 25.6%. Q3 net income decreased slightly while EPS rose, with weighted-average shares lower.
- Share repurchases reduced shares outstanding to 11.404 million from 11.780 million at year-end 2017. The company repurchased $148.6 of stock in the first nine months; approximately $270.5 remained under the authorization at September 30.
Outlook, risks, and notable items
- No specific near-term earnings or sales guidance was provided. Management expects long-term petroleum-additives industry shipment demand to grow at an average annual rate of 1%–2%, aims to exceed that rate, and identified margin improvement as its top priority while raw-material prices remain elevated. The company expects 2018 capital spending of $70–$80 million and stated that cash from operations and available borrowing should cover operating needs and planned capital spending for at least 12 months.
- Management’s stated shareholder objective is a 10% compounded annual return over any five-year period, defined as EPS growth plus dividends; it cautioned that this may not be achieved every year. It expects continued investment in talent, technology, and global infrastructure and will consider acquisitions, dividends, and repurchases as uses of cash.
- Key risks cited include raw-material availability and price increases, manufacturing or distribution disruption, competition, significant customer losses, foreign-exchange movements, international and regulatory exposure, cybersecurity or IT failures, and environmental or legal matters.
- Environmental remediation and related accruals were approximately $14 million. Management considers known matters adequately accrued but cautioned unexpected future costs could significantly affect financial position, results, or cash flows. The EPA had not notified Afton or Ethyl of findings or conclusions from its TSCA inspection; management did not expect the self-audit or inspection to have a material adverse effect.
- The company recorded a $6 million Q3 tax benefit associated with the Tax Reform Act and was still evaluating provisional tax calculations and its GILTI accounting policy; final adjustments were expected no later than Q4 2018. Adoption of ASC 606 had no income impact. The report also notes a $86 million write-off of fully depreciated, unused property and accumulated depreciation, with no impact on net PP&E; prior periods were not revised because the adjustment was not material.
Investor verification points
- Track whether selling-price increases catch up with raw-material and conversion-cost inflation and restore petroleum-additives margins.
- Monitor shipment volumes, regional sales trends, foreign-exchange effects, and customer demand against management’s long-term industry-growth view.
- Assess working-capital needs, pension contributions, cash generation, debt growth, and continued shareholder distributions and repurchases.
- Verify final Tax Reform Act and GILTI accounting outcomes, and any changes to environmental accruals or EPA TSCA matters.
- Compare actual 2018 capital spending with the $70–$80 million expectation and assess whether investments improve operating results.