Business context and reporting period
Stepan Company’s Form 10-K reports fiscal 2015, the year ended December 31, 2015; it is not a standalone fourth-quarter filing. The company manufactures specialty and intermediate chemicals in three segments: Surfactants, Polymers, and Specialty Products. Surfactants represented 68% of 2015 sales, Polymers 28%, and Specialty Products 4%. About 40% of sales were outside the United States.
Fourth-quarter figures are shown separately below where useful. The company reported no customer representing more than 10% of consolidated revenue in 2015, 2014, or 2013.
Financial performance and position
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Net sales | $1,776.2 million | $1,927.2 million | Down 8% |
| Gross profit | $308.2 million | $249.6 million | Up 23% |
| Operating income | $122.8 million | $90.7 million | Up 35% |
| Net income attributable to Stepan | $76.0 million | $57.1 million | Up 33% |
| Diluted EPS | $3.32 | $2.49 | Up 33% |
| Operating cash flow | $183.3 million | $82.0 million | Up $101.3 million |
| Capital expenditures | $119.3 million | $101.8 million | Up $17.5 million |
Gross margin increased to approximately 17.4% from 13.0%, and operating margin rose to approximately 6.9% from 4.7%. Sales volume increased 5%, but the benefit was more than offset by $131.8 million of unfavorable foreign currency translation and $115.8 million from lower selling prices, largely reflecting raw-material pass-through arrangements. Lower input costs and improved segment performance helped lift margins and profit.
Segment results: Surfactants sales were $1,205.8 million, down 7%, while operating income increased 71% to $104.1 million. Polymers sales were $491.5 million, down 11%, while operating income increased 33% to $80.9 million. Specialty Products sales declined 1% to $78.8 million and operating income fell 58% to $4.4 million, mainly due to higher raw-material costs and expenses.
Fourth quarter: Net sales were $419.3 million versus $454.2 million in Q4 2014; operating income was $20.2 million versus $9.0 million; net income attributable to Stepan was $12.9 million versus $6.2 million; and diluted EPS was $0.56 versus $0.27.
At year-end, cash and cash equivalents were $176.1 million, working capital was $376.3 million, and the current ratio was 2.5. Total debt was $332.6 million, up from $273.9 million; net debt declined to $156.5 million from $188.7 million. The company had $120.3 million available under its $125 million revolving credit facility, net of outstanding letters of credit, and stated it was in compliance with debt covenants. The annual dividend was $0.73 per share, compared with $0.69 in 2014.
Material changes, outlook, risks, and unusual items
- Surfactants and Polymers drove the operating-income improvement. In North America, lower raw-material and transportation costs, improved margins, and volume growth supported results. Specialty Products weakened.
- Foreign currency translation reduced 2015 sales by $131.8 million and operating income by $13.2 million year over year. Deferred compensation moved from $11.9 million of income in 2014 to $6.5 million of expense in 2015, an adverse $18.4 million operating-expense swing linked substantially to the change in Stepan’s share price.
- In 2015, Stepan acquired P&G Brazil’s Bahia surfactant facility for $5.1 million and purchased selected SUN Pasadena manufacturing assets and land for $13.0 million. A long-term SUN supply agreement began in Q3, supporting North American capacity utilization. The acquired P&G business had an insignificant contribution to post-acquisition results.
- Stepan and Nalco agreed to dissolve the TIORCO enhanced-oil-recovery joint venture amid low and forecast oil prices. Stepan recorded $2.4 million of its share of exit costs. Management expected the dissolution’s net earnings effect to be positive, despite higher internal operating expenses; wind-down was expected to finish in Q1 2016.
- A $2.9 million gain was recorded on the sale of the specialty polyurethane systems product line. The 2014 comparison included $4.0 million of restructuring and asset-impairment charges, a $2.4 million Polymer customer bad-debt charge, and a $7.1 million increase in the Maywood remediation estimate.
- Management expected 2016 to build on 2015 momentum, citing a full year of higher North American commodity sulfonation volumes, continued growth in core polymer markets, diversification, and lower costs from restructuring. Offsetting factors included China start-up costs and lower growth, plus a government-mandated 30-day shutdown of the German facility in Q4 2016. Specialty Products was expected to improve following 2015 structural actions. Planned 2016 capital expenditures were $115 million to $135 million.
- Key risks include manufacturing outages, raw-material and energy price volatility and supply disruption, intense competition, transportation interruptions, foreign exchange and international-market exposure, environmental and product-regulation liabilities, customer reformulations, and debt covenant or refinancing constraints.
- Environmental and legal losses were estimated at $20.9 million to $41.4 million; the accrued liability was $20.9 million. The Maywood groundwater Record of Decision remained outstanding, and remediation estimates could change. The company reported that certain other site exposures could not be reasonably quantified.
Important facts for investors to verify
- How much of the earnings and margin improvement is sustainable after accounting for lower input costs, deferred-compensation volatility, the product-line sale gain, and the prior-year charges?
- Whether the SUN supply agreement and the Brazil acquisition deliver expected volume, utilization, and returns, and how the Nanjing plant start-up affects 2016 Polymer results.
- The timing and cost implications of the German shutdown, TIORCO wind-down, and planned capital program.
- Potential changes in Maywood and other environmental liabilities, including the unresolved groundwater remediation decision and unquantified site exposures.
- Debt maturities, covenant headroom, dividend restrictions, and the extent to which cash held by foreign subsidiaries is available for U.S. purposes.