Stepan Company — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Unaudited results; comparisons are with the corresponding 2016 periods. Stepan produces intermediate chemicals through Surfactants, Polymers and Specialty Products segments.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $487.8m | $445.0m | $1,451.2m | $1,345.5m |
| Gross profit | $75.6m | $83.4m | $257.7m | $269.8m |
| Operating income | $30.3m | $28.7m | $115.3m | $116.3m |
| Net income attributable to Stepan | $21.9m | $21.4m | $81.7m | $77.8m |
| Diluted EPS | $0.94 | $0.92 | $3.50 | $3.38 |
| Declared dividends per share | $0.21 | $0.19 | $0.62 | $0.57 |
- Q3 gross margin was approximately 15.5%, versus 18.7% a year earlier; operating margin was approximately 6.2%, versus 6.5%. For the nine months, gross margin was approximately 17.8%, versus 20.1%.
- Q3 sales grew 10%, primarily from higher selling prices reflecting raw-material cost pass-throughs ($34.2m of the increase); favorable currency added $6.1m and volume added $2.5m. Nine-month sales rose 8%, but volumes declined 2%; price increases contributed $140.1m.
- Q3 reported operating income rose 5%, while adjusted net income fell 16% to $21.4m and adjusted diluted EPS fell to $0.92 from $1.10. Nine-month reported net income rose 5%, but adjusted net income declined 2% to $84.0m and adjusted diluted EPS declined to $3.60 from $3.73.
- Q3 operating income benefited from a $7.5m favorable year-over-year change in deferred-compensation expense, largely linked to Stepan’s share-price movement. Excluding this and other specified adjustments, adjusted earnings were weaker.
Segment trends
| Segment | Q3 sales change | Q3 operating income change | Key factor |
|---|---|---|---|
| Surfactants | +11% | +$1.7m, +8% | Latin America growth, including acquired businesses, was offset in gross profit by weaker Asia results. |
| Polymers | +10% | −$6.0m, −22% | Higher raw-material costs and lower North American volume/margins; equipment issues also increased overhead. |
| Specialty Products | −9% | −$1.3m, −58% | Lower volume and less favorable product mix/timing. |
For the first nine months, Surfactants operating income increased 8%, Polymers declined 21%, and Specialty Products increased 19%. Selling-price increases lifted sales, but did not fully offset higher input costs in parts of the business.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $124.7m, compared with $119.5m in 2016. Capital expenditures were $57.9m, versus $69.8m; investing cash use was $63.0m. Financing cash use was $29.9m, including $13.8m of dividends and $4.5m of open-market share repurchases.
- Cash and cash equivalents were $264.1m at September 30, up $38.4m from year-end 2016. Total debt was $304.4m, down from $317.0m; net debt was $40.3m, down from $91.3m. The filing reports total debt to debt plus shareholders’ equity of 29.3% and net debt to net debt plus shareholders’ equity of 5.2%.
- The $125m revolving credit facility had no borrowings; $120.3m remained available after $4.7m of letters of credit. The company said it was in compliance with debt covenants and expected to remain compliant through 2017.
- Management said cash, operating cash flow and committed credit facilities should fund planned capital needs, working capital, dividends and other commitments for the foreseeable future. Cash held outside the U.S. was $133.4m.
Outlook, risks and notable items
- Management remained optimistic about full-year adjusted earnings growth. It cited expected nonrecurrence of certain Q4 2016 expenses, diversification and efficiency efforts, and progress recovering Polymer raw-material costs. It also noted persistent increased North American competition. No numerical earnings guidance was provided.
- 2017 capital expenditures were estimated at $85m–$95m, including capacity expansions in the U.S., Brazil and Germany.
- Stepan agreed to acquire a BASF surfactants facility and related business in Ecatepec, Mexico; closing was expected in Q1 2018, subject to conditions. The company said the deal should strengthen its Mexican market position and supply capacity.
- Environmental and legal losses were estimated at $25.0m–$46.1m; $25.0m was accrued at September 30. Management considered the matters not expected to materially affect financial position overall, but said adverse determinations could materially affect cash flows or results in a period. Costs for certain sites could not be estimated.
- The Longford Mills, Canada, closure was completed in 2016; decommissioning continued, with $0.4m of Q3 restructuring expense and a $0.9m remaining liability. A Singapore workforce reduction generated $0.1m of expense in Q2.
- Key disclosed risks include raw-material and energy cost/supply volatility, production disruptions, competition, demand changes, acquisition execution, foreign exchange, environmental compliance and contingencies, debt-covenant limits, capital-project execution and litigation.
Important facts for investors to verify
- Whether selling-price increases can offset raw-material inflation without further weakening volume or margins, particularly in Polymers.
- Whether Polymer operating performance recovers, including the effects of North American competition, customer share losses and phthalic-anhydride equipment reliability.
- How much reported earnings depend on volatile deferred-compensation and investment valuation effects; compare GAAP results with the company’s adjusted measures.
- Progress toward the stated full-year adjusted earnings-growth outlook and the $85m–$95m capital-expenditure plan.
- Closing conditions, purchase economics and expected contribution from the planned Ecatepec acquisition.
- Developments in environmental and legal matters, including whether estimated losses exceed the $25.0m accrual.