NewMarket Corporation (NYSE: NEU) — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; comparisons are primarily with FY 2017. The company is a specialty chemicals holding company, with petroleum additives—lubricant and fuel additives produced mainly by Afton Chemical—as its principal business. Ethyl’s antiknock compounds and contracted services are reported as “All other.”
Financial performance and position
| Metric | FY 2018 | FY 2017 | Change / context |
|---|---|---|---|
| Net sales | $2,289.7 million | $2,198.4 million | Up 4.2% |
| Gross profit / margin | $585.4 million / 25.6% | $636.4 million / 28.9% | Profit down 8.0%; margin compressed |
| Operating profit / margin | $292.7 million / 12.8% | $322.7 million / 14.7% | Down 9.3% |
| Net income | $234.7 million | $190.5 million | Up 23.2% |
| Diluted EPS | $20.34 | $16.08 | Up 26.5% |
| Cash from operations | $197.9 million | $242.8 million | Down $44.9 million |
| Capital expenditures | $74.6 million | $148.7 million | Lower than prior-year investment level |
- Sales drivers: Petroleum additives sales rose 4.3% to $2.281 billion. Higher selling prices and favorable foreign currency added about $103 million; shipments reduced sales by about $9 million, with volume down 2.8%. Lubricant additives sales were $1.871 billion and fuel additives sales were $410 million.
- Profitability: Petroleum additives operating profit fell 9.9% to $311.0 million; segment operating margin declined to 13.6% from 15.8%. Management attributed pressure chiefly to higher raw-material and conversion costs, with a lag in recovering costs through pricing. Consolidated gross margin also reflected these cost pressures.
- Taxes and unusual comparison: The effective tax rate was 19.1%, versus 39.6% in 2017. FY 2017 included a $31 million net tax expense from U.S. tax reform, including the one-time tax on deemed repatriation of foreign earnings. This materially affects the year-over-year net-income comparison.
- Fourth quarter: FY 2018 Q4 sales were $538.3 million, gross profit $141.8 million, net income $62.8 million, and diluted EPS $5.58. FY 2017 Q4 sales were $560.0 million, gross profit $145.2 million, net income $4.1 million, and EPS $0.35; the unusually low 2017 result included the tax-reform charge.
- Cash and liquidity: Cash was $73.0 million at year-end, including approximately $71 million held by foreign subsidiaries. Working capital was $542.1 million and the current ratio was 3.00, versus 2.63 in 2017. Operating cash flow was reduced by higher working-capital needs and $64.8 million of pension and postretirement contributions.
- Debt: Long-term debt was $771.0 million, up from $602.9 million; debt was 61.1% of total capitalization, versus 50.1%. The company had $168.1 million drawn on its $850 million revolving facility and $679 million of unused capacity. It reported compliance with debt covenants; year-end leverage and interest-coverage ratios were 2.00 and 11.89, respectively. Cash less long-term debt was approximately negative $698 million.
- Capital returns: NewMarket repurchased 603,449 shares for approximately $232 million in 2018 and paid $80.4 million in dividends. The annual dividend was $7.00 per share. A new $500 million repurchase authorization took effect January 1, 2019 and runs through December 31, 2021.
Material changes versus FY 2017
- Sales increased, but lower shipment volume and sharply higher raw-material and conversion costs contributed to lower gross and operating profit.
- Cash from operations declined, while pension contributions rose substantially. The company funded buybacks, dividends, and capital spending partly with $168 million of revolving-credit borrowings.
- Capital expenditures declined to $74.6 million from $148.7 million. The year-end construction-in-progress balance also fell substantially as major projects advanced.
- Shareholders’ equity decreased to $489.9 million from $601.6 million, reflecting repurchases, dividends, foreign-currency translation and pension-related changes, partly offset by earnings.
Outlook, risks and contingencies
- Outlook: Management expected another solid year for the petroleum additives segment in 2019. It cited long-term industry shipment-demand growth of 1%–2% and intends to outgrow the industry. Planned 2019 capital expenditures were $75–$85 million. The company’s stated shareholder-return goal is a 10% compounded annual return over any five-year period, defined as EPS growth plus dividends; management cautioned it may not achieve 10% in every year.
- Key risks: Raw-material availability and price volatility, limited or single-site production for some products, distribution disruptions, competitive pricing, dependence on concentrated lubricant and fuel markets, technology and product-development risk, foreign-exchange and geopolitical exposure, regulation, cybersecurity, and debt-related constraints. More than 65% of 2018 sales were outside the United States; Brexit remained uncertain.
- Environmental and legal matters: Environmental remediation, dismantling and decontamination accruals were approximately $12 million at year-end, versus $14 million in 2017. Environmental operating and cleanup costs were about $30 million in 2018; management expected 2019 spending at a level similar to recent years. In November 2018, the company resolved its purported Sauget Area 2 Superfund liabilities. A Clean Air Act settlement concerning the Sauget facility included a $0.3 million penalty, with discussions continuing on whether part could be addressed through supplemental environmental projects. The company reported a $10 million accrual for asserted premises-asbestos claims and $5 million of related expected recoveries.
- Pensions and accounting: Pension assets are substantially equity-weighted, exposing required contributions and reported costs to market performance. Adoption of lease accounting in 2019 was expected to add approximately $70 million of right-of-use assets and lease liabilities, without a material effect on net income, liquidity, or debt-covenant compliance.
- Controls and audit: Management and the independent auditor concluded internal control over financial reporting was effective as of December 31, 2018; the auditor issued an unqualified opinion on the financial statements.
Important facts for investors to verify
- Whether pricing actions can recover raw-material and conversion-cost inflation, and whether shipment volumes stabilize after the 2.8% decline.
- The sustainability of margins and cash generation, particularly given lower operating profit, increased pension contributions, and working-capital demands.
- Debt repayment plans, borrowing costs, covenant headroom, and the balance between share repurchases, dividends, and investment spending.
- The basis for management’s 2019 expectation to outperform industry shipment growth and the timing and returns of Singapore, Mexico, and other infrastructure investments.
- Potential developments in environmental and legal matters, including the remaining terms of the Clean Air Act settlement and uncertain remediation costs.
- The effect of foreign-exchange movements, overseas operations, and pension-asset performance on future results and liquidity.