Quaker Chemical Corporation (NYSE:KWR) Q4 2023 Earnings Call Transcript

Quaker Chemical Corporation (NYSE:KWR) Q4 2023 Earnings Call Transcript March 1, 2024

Quaker Chemical Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to the Quaker Houghton Fourth Quarter and Full Year 2023 Earnings Conference Call. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Jeffrey Schnell, Vice President of Investor Relations. Mr. Schnell, you may begin.

Jeffrey Schnell: Thank you. Good morning and welcome to our Fourth Quarter and Full Year 2023 Earnings Conference Call. On the call, today, are Andy Tometich, our President and Chief Executive Officer; Shane Hostetter, our Executive Vice President and Chief Financial Officer; and Robert Traub, our General Counsel. Our comments relate to the financial information released after the close of the U.S. markets yesterday, February 29, 2024. Our press release and accompanying slides can be found on our Investor website. Both the prepared commentary and discussion during this call may contain forward-looking statements reflecting the company’s current view of future events and their potential effect on Quaker Houghton’s operating and financial performance.

These statements involve uncertainties and risks, which may cause actual results to differ. The company is under no obligation to provide subsequent updates to these forward-looking statements. This presentation also contains certain non-GAAP financial measures and the company has provided reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures in the appendix of the presentation materials, which are available on our website. For additional information, please refer to our filings with the SEC. Now, it is my pleasure to hand the call over to Andy.

Andrew Tometich: Thank you, Jeff and good morning everyone. Quaker Houghton finished 2023 strong. For the full year we generated record net sales of $1.5 billion, adjusted EBITDA of $320 million, and non GAAP earnings per share of $7.65. We also showcased the cash generation capabilities of the enterprise, generating a record $280 million of operating cash flow for the full year, strengthening our financial position. Our performance was empowered by the team’s ongoing execution on our margin initiatives aimed at improving the profitability of our business and our focus on the future never wavered. In 2023, we made considerable progress advancing our enterprise strategy and enhancing our customer intimate model, delivering valuable services and solutions to our customers.

Together, we successfully managed through significant macroeconomic headwinds that our company and our customers have faced, and I am proud of our collective accomplishments in 2023. Our results in the fourth quarter were in line with our expectations. Fourth quarter net sales were $467 million, 4% lower than the prior year, but with stable volumes. Net sales were down 5% compared to the third quarter, but largely in line with our expectations and the fourth quarter normally has seasonal impacts, primarily in the Americas and EMEA segments. The fourth quarter and the full year highlighted the resilience of our business. In fact, our volumes in 2023 have remained stable sequentially throughout the entire year despite the challenging end market conditions in all regions.

In 2023, we focused on our top financial priority of recovering our margin profile while balancing customer relationships and the long-term aspirations of our business. Our team delivered. Gross margins in the fourth quarter were 36.6%, nearly 4.5 percentage points higher than the prior year and near our long-term target range in a seasonally lower quarter. This improvement reflects successful execution on our margin recovery initiatives as well as moderating raw material costs, which remain at historically elevated levels. In the fourth quarter we also generated adjusted EBITDA of $77 million a 13% increase year-over-year and $1.78 of non-GAAP diluted earnings per share, a 28% increase compared to the prior year. These results were a function of our clear focus on providing the best solutions for our customers as we worked together managing the complexities of the market environment.

Cash flow was a highlight once again in the fourth quarter. We generated an additional $81 million of operating cash flow in the fourth quarter, and in total we generated $279 million of operating cash flow in 2023, driven by our improved operating performance and active working capital management. In addition, our strong cash generation enabled us to reduce our variable rate debt by approximately $200 million in 2023. Our net leverage ratio also improved and is now 1.8 times adjusted EBITDA, the lowest level since the combination in 2019. Our strong cash flow and strong financial position continued to provide significant optionality for the enterprise to generate long-term value. Turning to our segments, we once again delivered improved earnings and margin performance in all our segments on a year-over-year basis.

As expected, in the fourth quarter, market conditions remained soft in both metals and metalworking, and our volumes largely reflected our underlying markets in each region. Volumes in the Asia Pacific and EMEA segments increased compared to the prior year’s same quarter. Our increase in the EMEA segment was due to the timing of orders and new business wins, and while EMEA volumes improved slightly in the fourth quarter, volumes in this segment remained significantly below normalized levels, as industrial activity remains constrained in the region. The year-over-year increase in our volumes in Asia Pacific segment in the quarter was due to an improved demand in both metals and metalworking across Asia. China itself was consistent with the prior year period, which was a solid result considering the Lunar New Year was more of a benefit to the fourth quarter of 2022.

Volumes in the Americas segment declined compared to the prior year, largely reflecting the softer overall demand environment, especially in industrial applications. Our metals business saw improved volumes in the Americas. On a sequential basis overall volumes in the quarter declined approximately 3%. This was comprised of increases in EMEA and Asia Pacific and a decline in the Americas, primarily relating to normal seasonal patterns. I am pleased that we continue to perform in line or better than our underlying markets, while also taking actions to better position the company for long-term profitable growth. I expect we will continue to grow from these low levels as we move through 2024. Switching to the full year 2023 was a successful year for Quaker Houghton.

We are encouraged that volumes have remained stable throughout 2023 despite soft underlying end market conditions and our prudent margin improvement initiatives. Importantly, we continue to gain additional business and these gains are trending within our expected long-term range. We remain focused on earning appropriate value for the product and service solutions we provide. In 2023, price and product mix increased approximately 7% year-over-year. Combined with a moderate improvement in raw material costs, we drove a 460 basis point improvement in gross margin and a 25% increase in adjusted EBITDA, while continuing to invest in our people and our growth pillars. And as I mentioned previously, we also generated record cash flow in 2023, strengthening our balance sheet.

In summary, our 2023 performance positions us to invest in and capitalize on the opportunities ahead. Switching to the outlook, we expect another solid year for Quaker Houghton in 2024 building on the accomplishments we have already achieved. Beginning with the first quarter, we anticipate that the current difficult market conditions and uncertainty will persist. We expect a seasonal improvement in demand led by the Americas and to a lesser extent the EMEA segment, which will in turn drive an increase in net sales compared to the fourth quarter of 2023. And while trends in Asia Pacific segment appear to be improving, growth in that region will be tempered in the first quarter compared to the fourth quarter due to the Lunar New Year holiday.

We remain encouraged by the demand outlook in aerospace and primary metals markets as well as our China and greater Asia Pacific businesses. Raw material costs have stabilized and we expect gross margins will be similar to fourth quarter levels. Therefore, we expect adjusted EBITDA growth on a sequential and year-over-year basis in the first quarter of 2024. For the full year we expect the current end market environment will likely persist throughout the first half of 2024. We are cautiously optimistic on end market and raw material cost outlooks, and we expect to continue benefiting from the diversification of our portfolio leading to volume growth in 2024. Our team is highly focused on executing on our priorities, controlling what we can control.

We have demonstrated considerable progress on our margin recovery journey and we have more opportunity. We also anticipate making further progress on our enterprise strategy; investing in our foundation, advancing our growth pillars and contemporizing our organization. We will continue investing in our talented people as well as our internal systems and processes, building our capabilities and advancing our customer intimate model for the future. Taken together, we expect to deliver another year of earnings growth in 2024. And consistent with our history, we also forecast another strong year of cash generation. We remain committed to our capital allocation priorities, investing in our organic growth, paying dividends, advancing our bolt-on M&A strategy, and strengthening our balance sheet through debt repayment.

Additionally, while we intend on prioritizing growth investments consistent with our commitment to enhancing shareholder value, our Board has also approved a new $150 million share repurchase authorization. Quaker Houghton is fully committed to our growth strategy. The end market environment has continued to test our resolve, but our team has not lost focus on our priorities centered on enhancing the value we provide to our customers. We have managed through the immediate challenges our business has faced while maintaining our focus on the future. We have also improved our foundation. We are driving efficiencies and we are optimizing our processes and offerings, augmenting the durability of our differentiated customer intimate business model.

Our strategic pillars remain centered on leveraging our global scale, deploying digital capabilities and leading in sustainability. These pillars are positioning Quaker Houghton to continue to meet the current and long-term needs of our customers and deliver value for our company and our shareholders. Leveraging our scale remains a critical way to advance and optimize the intimacy of our model, including with our direct and indirect channel strategy. We initially embarked on this improvement area in the U.S. and we expect to make further progress on this work in 2024 expanding into Europe. Leveraging our global scale also helps to drive new business wins. We do so by deploying, reinforcing and expanding the full capabilities of our technology portfolio.

Consistent with this, in the first quarter, we bolstered our portfolio of specialty greases with the acquisition of IKV Tribology in Europe. This acquisition complements our portfolio of advanced and operating solutions and will help accelerate our growth in these areas.

FLUIDTREND: As an example, the electrification of the automobile is providing several nascent, but real and meaningful opportunities for us to accelerate our growth. These new opportunities have tremendous challenges and complexities, which is exactly the space where we thrive. We are working diligently to develop and drive leadership with value adding solutions in these areas for our customers. These are just some of the examples of the important initiatives that we are advancing at Quaker Houghton. They are natural extensions of our differentiated customer intimate approach and are additive to our potential as we position the company for the decades of growth ahead. Overall, we remain focused on and committed to capitalizing on the positive momentum we have built with our enterprise strategy to further unlock our potential.

Our industry has attractive long-term growth characteristics and we have earned a leading position gaining the trust of our customers by providing them with the best services and solutions. We are well positioned from a financial and operational perspective, having improved our profitability, strengthened our balance sheet and restored the cash generation capabilities of the organization. We will never lose sight of our mission, driving success for and with our customers. This partnership fuels our ability to earn new business as we support our customers, helping them to manage complexity and enabling them to pursue new opportunities. We will continue to prudently invest to advance our growth initiatives. It is through our strategic pillars, our leading portfolio of products and services, and our customer intimate solution based business model that we will achieve profitable above market growth.

And we remain committed to our balanced capital allocation strategy as we focus on maximizing shareholder value. I am proud of the execution and performance throughout 2023 and I am confident in our ability to move forward together for our customers and our company. With that, I’d like to pass it over to Shane to discuss the financials.

Shane Hostetter: Thank you Andy and good morning everyone. The fourth quarter was another solid quarter for Quaker Houghton. As expected, our net sales declined approximately 4% from the prior year to $467 million. The main drivers of the change were lower price and mix of approximately 4% as well as a 1% decline in sales volumes, which were partially offset by a favorable impact from foreign currency translation of 1%. While volumes were largely consistent with the prior year, they also reflect softer global industrial activity, as well as the direct and indirect impacts of the UAW strikes in the Americas, which primarily impacted our metal working businesses. Customer order patterns also impacted. For example, in China related to the timing of the Lunar New Year in 2023.

These headwinds were partially offset by new business wins, improvements in our metals businesses globally, as well as an improved performance in our greater Asia Pacific region. Though we continued to implement targeted actions, our price and product mix did decline compared to the prior year. This primarily reflects our indexed based contracts which represent approximately a quarter of our overall volumes as well as impacts due to product mix. Sequentially, net sales declined approximately 5%. This was primarily driven by a volume decline of approximately 3%, reflecting normal seasonal patterns in the Americas business, which was muted by improvements in the EMEA and Asia Pacific segments. Gross margins in the third quarter were 36.6%, which represents an increase of 440 basis points compared to 32.2% in the prior year.

This improvement reflects the continued execution on our margin improvement initiatives as well as a moderate decline in our raw material costs. Sequentially, gross margins declined by approximately 80 basis points due to the impact of the seasonally lower production volumes. Excluding onetime items, SG&A increased $13 million or 11% compared to the prior year, but declined $1 million or 1% sequentially. The increase compared to the prior year reflects inflationary impacts on our labor and related costs as well as impacts due to foreign exchange. Overall, we delivered $77 million of adjusted EBITDA in the fourth quarter, which represents an increase of 13% compared to the prior year. Our adjusted EBITDA margins were 16.5% in the quarter or 250 basis points higher than the prior year.

These improvements reflect the progress we’ve made advancing our strategy while balancing our near-term priorities with our long-term profitable growth initiatives. Switching to our segments, net sales in the Americas declined 7% year-over-year, driven by softer end market activity, primarily in our metal working businesses and to a lesser extent selling price and product mix. On a sequential basis, America’s net sales and volumes declined due to normal seasonal patterns, which we previously anticipated. America’s had consistent price and product mix with the prior quarter. America’s segment earnings increased approximately 4% compared to the prior year, primarily reflecting our margin improvement initiatives. For the full year, America’s margins increased 360 basis points, which drove segment earnings higher by 19% year-over-year.

Net sales in our EMEA segment were consistent with the prior year as higher sales volumes and a favorable impact from foreign currency translation were offset by lower selling price and product mix. Our EMEA volumes have stabilized, but they still remain at low levels as we continue to contend with very soft end market conditions in most product categories. Sequentially, EMEA’s net sales declined 3% as sequential increases in sales volumes were offset by price and product mix and the unfavorable impact of foreign currency translation. EMEA’s segment earnings increased approximately 35% in the fourth quarter compared to the prior year. This increase reflects our margin improvement initiatives as well as overall cost actions. Similarly, full year earnings in the EMEA segment increased approximately 37% compared to 2022.

Net sales in Asia Pacific were consistent with the prior year as an increase in volumes were offset by both price and product mix as well as an unfavorable impact from foreign currency exchange. Increased sales volumes were driven predominantly by demand improvements and new business wins, primarily in greater Asia and also broadly across metals and metalwork. Sequentially, net sales in Asia Pacific were also consistent with the third quarter. Asia Pacific segment earnings increased approximately 7% compared to the prior year, which was largely driven by gross margin improvement. For the full year, Asia Pacific’s segment margins increased approximately 490 basis points, which drove a 12% increase in earnings compared to 2022. Overall, we have made considerable progress in 2023, improving the financial profile of all of our segments, which positions us well heading into 2024.

Below the line, our interest expense was slightly lower in the fourth quarter compared to both the prior year and prior quarter, which reflects our commitment to debt reduction. Our cost of debt in the fourth quarter was approximately 6.2%, which is in line with where we exited the prior quarter. Our effective tax rate, excluding nonrecurring and noncore items, was approximately 30% in the fourth quarter and 28% for the full year. We expect our effective tax rate in 2024 to be approximately 29%. Our GAAP diluted earnings per share were $1.12 and our non-GAAP diluted earnings per share were $1.78. This represents a 28% year-over-year increase in earnings per share, which was driven by an improvement in operating earnings. Switching to liquidity we generated an additional $81 million of cash from operations in the fourth quarter.

For the full year, we generated a record $279 million of operating cash flow. Our cash flow improvements reflect higher earnings as well as our focus on improving our overall working capital efficiency. Capital expenditures for the full year 2023 were $39 million, which includes $13 million in the fourth quarter. Also, we paid an additional $8 million of dividends to shareholders in the quarter, increasing total dividends paid to $32 million for the full year. In addition, we reduced our variable rate debt by $204 million in 2023, including a repayment of $78 million in the fourth quarter, which will reduce our interest expense in 2024. Our balance sheet and liquidity are strong. Our net debt at the end of the fourth quarter was $561 million and our net leverage ratio improved to 1.8 times our adjusted EBITDA.

This represents the lowest level of leverage for the company since the combination occurred in 2019 and is a testament to the legacy of the strong cash generation capabilities of our company. Looking to 2024, we expect another strong year of cash generation, supported by earnings growth as well as our ongoing working capital efficiency efforts. Our capital allocation priorities remain unchanged. We will continue to prioritize investments in our company. For full year 2024 we anticipate the range of our CAPEX spend to remain unchanged at approximately 1.5% to 2.5% of net sales. We will continue to build on our long history of dividends. We will continue to advance our M&A pipeline with attractive and accretive transactions that support our enterprise strategy.

And while we will prioritize growth, we will also be opportunistic, including potentially through share repurchases to enhance shareholder value. In summary, 2023 was a very successful year for Quaker Houghton. We executed on our margin improvement initiatives, which increased segment margins by 400 basis points across all of our segments, despite significant end market challenges. We delivered record results and cash flow generation and we remain disciplined with our capital allocation priorities. We are committed to our growth strategy and we remain confident in the earnings power and cash generation capabilities of this company and we believe we are well positioned to continue to deliver long-term shareholder value. With that, I’ll turn it back over to Andy.

Andrew Tometich: Thank you, Shane. 2023 was a very successful year for Quaker Houghton, and we’re excited about the opportunities ahead. I’d like to thank the entire organization for their commitment to our company and our customers and for living our core values every day. With that, we’d be happy to address your questions.

Operator: Thank you. [Operator Instructions] One moment, please, while we poll for questions. Our first question is from Mike Harrison with Seaport Research Partners. Please proceed.

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Q&A Session

Michael Harrison: Hi. Good morning. Congrats on a nice finish to the year.

Andrew Tometich: Good morning, Mike thanks.

Michael Harrison: Just looking at this price mix number down 4% year-over-year, you mentioned that about a quarter of that was related to the indexed contracts, but I get a sense that mix was negative. So I was just curious if you can provide any color on the mix component there? Is that regional? Is that dynamics within some particular end market or particular product line? And do you expect that to normalize as we get into 2024? Just trying to get a sense of kind of what the underlying pricing and the mix component could look like into next year.

Andrew Tometich: Yes. Thanks Mike. A really good question. So, yes, we did highlight that price and mix declined in the fourth quarter on a year-over-year basis. And actually, the split is about half and half between price and product mix. On the mix side, it relates to order patterns and as a typically temporary situation, not any main pattern that I would highlight. When we think about the price piece of it, we’re lapping prior year price increases when we look on a year over year basis, kind of as expected. And then we did have raw material decline modestly in the second half of the year, and we have about 25% of our entire business that’s on indexed contracts. So those were impacts, but largely, we’ve seen stable pricing throughout the year and I would still highlight, too, we improved 7% in 2023 and so we’re going to continue to work with customers on earning the value for the things that we do to help them solve problems and earn profitable new business.

Michael Harrison: All right. And just switching over to capital allocation, it seems like you’re well positioned to have some nice flexibility here, given the balance sheet and the cash flow. But maybe just help us understand if anything has really changed in terms of your priorities. Given this share repurchase authorization, how should we think about prioritizing repurchases against bolt-on acquisitions? And I guess if there’s any color you can share on kind of your approach and potential timing on repurchases. It’s been several years since you guys have done any meaningful share repurchases, so just curious to get your thoughts on the philosophy and the approach.

Andrew Tometich: Sure. Thanks Mike. First and foremost, we’re focused on growing the business, and the way we do that is by supporting customers, and in turn then we generate shareholder value, and we’ve got ample opportunities to do that, some of which I’ve highlighted, and we’ll continue to focus on that. But then the capital allocation strategy that supports that is not changed. It is unchanged and remains what we’ve talked about before. So we have been focused on some debt repayment here recently, which really has put us in a strong financial position to enable us to continue to focus on value creation. We’ve been committed to dividends. Last year we increased approximately 5%, and now we’re 47 out of 50 years have increased our dividend.

And then M&A is a key part of our growth levers to unlock value and our pipeline there is really healthy. We’re continuing to move opportunities along and evaluate new opportunities. Timing is not always predictable, but we are advancing that portfolio and we were really happy completing the IKB acquisition here recently that we highlighted. So we’re going to continue to prioritize organic and inorganic investments for the business. But we did put in place this active repurchase authorization that allows us to be opportunistic. But the key thing here is we have a balanced approach to our capital allocation. Nothing has changed, and we believe we have the right levers that will allow us to add shareholder value.

Michael Harrison: All right, thanks for that. And then last question for me is just in terms of the outlook, you guys are fairly encouraged on volume starting to recover and continuing down this path of margin recovery. But just curious, any additional modeling assumptions you can provide around volume, price, cost, and maybe kind of incremental margin leverage as we start to see these volumes turn around? Any other puts and takes that maybe we should keep in mind as we’re trying to model EBITDA growth in 2024?

Andrew Tometich: Yes, great. I’m happy to do that, Mike. So when I think about our outlook in total, I anticipate we’re going to have another good year for Quaker Houghton in 2024. So starting with the first quarter, the underlying markets we don’t think are going to change tremendously from the fourth quarter. There could be some benefit of seasonality in the Americas as we come off the fourth quarter, and our gross margins are going to be similar or maybe even slightly improved to the prior quarter. So in the first quarter, we anticipate EBITDA growth on a year-over-year and sequential basis, then transitioning to the full year, the visibility with some of the macro uncertainties makes it a challenge, but we anticipate underlying markets and kind of the current business to remain similar through the first half of 2024.

But all along, we’re going to be continuing to focus on what we do extremely well, which is earning new business by solving customer problems and driving value profitable volumes as we continue to do that. For gross margin, we’re not yet at our targeted levels. We made a lot of progress last year, but we still have some opportunities and we’ll continue to move towards our targeted range through cycle. For SG&A, we’ll continue to make investments in this business to be able to grow and there will be some inflationary impacts, although the pace of that, we believe, is going to be lower than what we’ve seen more recently. So taken together, another solid year for Quaker Houghton. It’s going to be driven by volume growth and margin improvement that translates into earnings growth for the enterprise.

And then last, I don’t want to miss out on cash generation. We’re going to continue being a solid cash generator with our model using that as part of our disabled [ph] capital allocation strategy. Again, where I just highlighted, we’ll prioritize growth and uncovering ways to add the most value for our shareholders.