Value Thoughts - KMG Chemicals, Inc.
KMG Chemicals, Inc. (NYSE: KMG), manufactures, formulates and globally distributes specialty chemicals for the electronics and wood treating industries.
The company recently exited the Animal Health Industry, selling it’s operation to Bayer Healthcare, LLP. in March 2012. This segement of the company’s business accounted for approximately 5% of FY11 net sales.
The company’s electronics chemical business produces wet process for the semiconductor industry. These chemicals are used to clean and etch silicon wafers during the production of semiconductors. This segment of the company’s business accounted for approximately 55% of FY11 net sales.
The company’s wood treating business produces penta and creosote for industrial customers who use the products to extend the useful life of wood products such as utility poles and railroad crossties. This segment of the company’s business accounted for approximately 40% of FY11 net sales.
The company began operations as an independent oil and natural gas exploration and production company in 1929, under the name Kerr-McGee Corporation. In 2006, Kerr-McGee was merged with Anadarko Petroleum Coporation and its chemicals business was spun off into KMG Chemicals.
Financial information presented herein, is based on the company’s most recent SEC Form 10-K filing for year ending July 31, 2011, as filed with the Securities and Exchange Commission on October 14, 2011.
Liquidity: The company ended FY11 with a current ratio of 2.1, a quick ratio of 1.0, a cash ratio of 0.04, and a cash conversion cycle of 89 days. The company also ended the year with a book value of $8.39. However, when goodwill and intangibles which comprise roughly 12.5% of the company’s total assets are factored in, the company’s tangible book value becomes $6.37.
Profitability: FY11 found the company with a gross margin of 29.6%, an operating margin of 19.44%, a net operation margin after taxes (NOPAT) of 17.5%, a return on invested capital (ROIC) of 35.7%, and an effective tax rate of 35.1%.
Debt: The company ended FY11 with total debt of $52.2 million, a year over year decrease of 13%. Additionally, the company paid an average annual interest rate 4.41%, a year over year increase of 13%, had a debt to cash ratio of 29, and a debt to equity ratio of 0.54.
Cash Flow: The company’s FY11 operating cash flow was $4.89 per share, a year over year increase of 78%. The company also ended FY11 with free cash flow of $4.08 per share, a year over year increase of 70%.
Dividends: During FY11 the company paid a $0.09 per share dividend, a year over year increase of 9%. Investors should always be aware that a company is never under any obligation to pay a dividend. Accordingly, there is no guarantee that future dividends will be declared.
Key Performance Indicators: We utilize numerous metrics when we analyze a company’s financial information. Of the metrics we use, there are seventeen that form our key performance indicators, or KPIs. We use these metrics because we believe they represent the influence management has on the day to day operation of the company. In the case of KMG Chemicals, we have assigned a KPI score of 78.
The company has several legal issues that investors should make themselves aware of before considering an investment in this equity.
On going litigation regarding third-party over billing, land ownership in Mexico, state sales tax disputes in Colorado, client payment recovery in client bankruptcy filings, and third-party health claims related to the company’s wood treating chemicals business, are current legal issues the company is dealing with.
Investors considering this company for future investment should read through the Legal Proceedings section of the company’s SEC 10-K filing, as filed with the SEC on 10/14/2011.
The stock closed recently at $17.76, with first resistance at the 52-week high of $19.72, an 11% increase from the recent close.
On the down side, the stock should find first support at $17.64, a 0.7% decline from its recent close. In addition the stock should find second support at $17.30, a 2.6% decline from its recent close. Should the stock price slip below second support, the next support level is $11.82, the 52-week low.
Our short-term equilibrium number, the mid point between resistance and support is $17.47, a 1.6% decline from the recent close. Accordingly we believe a short-term investment in this stock is ill advised at current price levels.
Earnings Growth Considerations
Earnings growth valuations are based on the spread between year over year earnings growth and the current PE.
In the case of KMG, the company had a year over year earnings growth of 1066%, ending FY11 with earnings of $4.04 per share versus $1.96 per share in the prior fiscal year.
With a trailing twelve month PE currently at 4, the spread between earnings growth and the PE is 24, meaning that for an investor focusing on earnings growth, the stock should be trading at $116.07, 554% higher than its recent close.
Based on our review of the company’s latest annual financial information we think a reasonable value estimate for the company is in the $41-$52 range.
Long-Term Investment Considerations
Considering a Recent Close of $17.76, an estimated Merger and Acquisition payback of a little under 5 years (assuming EBITDA remains the same), year over year earnings growth of 106%, our estimated reasonable value of $41-$52, and our KPI factor of 78, we believe on a fundamental investment basis, the stock is currently UNDER PRICED.
Our valuation worksheet for KMG Chemicals, Inc., which includes our current buy and sell targets, may be download by clicking here.
Please pay strict attention. All financial information is based on the company’s latest ANNUAL SEC 10-K filing. It is anticipated that the next SEC 10-K filing will occur in October of 2012.
I currently do not have a position in KMG Chemicals, Inc., and have no plans to initiate one in the next 72 hours. I have received no compensation to write about a specific stock, sector, or theme.