Stepan Company Is Making Great Progress (NYSE:SCL)

The last few months have not been particularly pleasant for shareholders of surfactants and specialty products firm Stepan Company (NYSE:SCL). You see, back when I last wrote about the company in February of this year, I rated the business a ‘hold’. This was based on declining revenue, profits, and cash flows. Management attributed these problems to weak demand for its products, as well as inventory destocking of its customers. Another factor in this decision was the fact that shares of the business were not all that attractively priced. As a value investor, that is incredibly important to me.

Usually when I rate a company a ‘hold’, it is my statement that shares are likely to perform more or less in line with what the broader market should achieve. But the stock is actually down 5.7% since then at a time when the S&P 500 is up 12.9%. Looking at newer data that has since come out, we can see that revenue continues to be weak. However, there does appear to be evidence of improvements. This is especially true on the company’s bottom line. Given this, combined with house shares are priced today, I am getting closer to upgrading the firm to a soft ‘buy’. But I’m not there quite yet.

The good news is that, before the market opens on July 31st, management is expected to announce financial results covering the second quarter of the company’s 2024 fiscal year. That opens up the door for some positive developments. And while management may have been reporting disappointing sales figures leading up to this point, analysts expect revenue to rise year over year and for profits to grow as well. If this does come to fruition and if we get some insight into further improvements, I could eventually see myself upgrading the stock.

Mixed results

By almost every measure that counts, Stepan Company had a very difficult 2023 fiscal year. In the chart above, you can see financial results for 2023 relative to 2022. Sales of $2.33 billion came in 16.1% below the $2.77 billion reported one year earlier. This was driven by pain across the board. Surfactants revenue, for instance, dropped by 14.9%, while Polymers sales fell by 18.6%. Even more painful was the 20.7% plunge seen by the company’s Specialty Products segment. As I mentioned at the start of this article, these sales declines were really driven by weak customer demand and inventory destocking. Some of this showed up in the form of lower volumes. However, the company also took a $130.4 million hit in the Surfactants segment associated with lower selling prices, while lower selling prices in the Polymers segment impacted sales negatively to the tune of $38.8 million.

The big drop in revenue brought with it a plunge in profits. Net income was cut by more than two thirds from $147.2 million to $40.2 million. Even if we look at it from an adjusted basis, we would get a fall from $153.5 million to $50.7 million. That’s not much better. It is true that operating cash flow managed to rise from $160.8 million to $174.9 million. But on an adjusted basis, it also fell, dropping from $229.7 million to $176.8 million. Meanwhile, EBITDA for the company dropped from $301.5 million to $180 million.

As painful as 2023 was, the company is showing some positive data this year. Unfortunately, none of this improvement is on the sales side. Revenue of $551.4 million in the first quarter of 2024 fell short of the $651.4 million reported the same time of 2023. Plunges across the board took place. However, this is not all it was cracked up to be. While the company did suffer from increased competition in some areas, such as Europe and Latin America for its Surfactants segment, much of the decline in revenue seems to have been driven by the firm’s ability to pass on lower raw materials costs to its customers.

This is where some of the good news comes into play. Even though revenue fell, and net income dropped from $16.1 million to $13.9 million, cash flows improved across the board. Operating cash flow, for instance, went from negative $72.1 million to positive $41.6 million. On an adjusted basis, operating cash flow expanded from $42 million to $45.2 million. Meanwhile, EBITDA for the company managed to grow from $48.7 million to $51.2 million.

Even though net income and adjusted net income fell year over year, the company benefited from margin expansion. This was less visible when we focus on net profits and adjusted net profits. But the company’s adjusted operating cash flow margin improved from 6.45% to 8.20%, while its EBITDA margin grew from 7.48% to 9.29%. As you can tell from the chart above, these margin improvements mark a turnaround compared to what the company saw from 2022 to 2023. We do know that management has been focusing on a $50 million cost cutting initiative. And it does look as though this is yielding some positive results.

Not every segment has been the same when it comes to bottom line changes. Most notably, higher unit margins and growing sales volumes associated with the company’s medium chain triglycerides product line were instrumental in pushing segment profits for the Specialty Products segment of the business up from $2.5 million to $4.3 million. For the company more broadly, there was also a reduction in selling expenses from 2.01% of sales to 2.07%. In addition to this, the company’s gross profit margin expanded from 11.29% of sales to 12.75%. While this may not seem like a significant change, when you apply the gross profit margin expansion to the revenue generated in the most recent quarter, that translates to an extra $8.1 million going to the firm’s bottom line on a pre-tax basis. Add on top of this reductions in research and development costs, and technical services fees, as well as a slight improvement in restructuring expenses, and it’s clear that things have gotten better.

As I mentioned near the start of this article, analysts do have high hopes for the second quarter of the 2024 fiscal year. Before the market opens on July 31st, that data is expected to come out. At present, analysts believe that revenue will be about $581.3 million. That would be a modest improvement over the $580 million reported the same time last year. But it’s not just revenue that’s expected to improve. Analysts also expect earnings per share to come in at around $0.65. That would be up from the $0.55 per share in profits generated in the second quarter of 2023. This would translate to an increase in net income from $12.7 million to $14.9 million. In the table above, you can also see historical results for other profitability metrics for the business. If profitability improves, these other metrics almost certainly will also.

While it’s great for analysts to have positive expectations, I would argue that shares are not cheap enough just yet. This could very well change if strong data indicating a return to normalcy does come out in the second quarter. And because of that, investors should pay careful attention. But as you can tell from the chart above, with a focus on the 2023 fiscal year, shares are not exactly cheap. I would place them more in the fair value territory. This also seems to be the case on a relative basis, as shown in the table below. In that table, you can see how the stock stacks up against five similar companies. On a price to earnings basis, Stepan Company is the most expensive of the group. But on a price to operating cash flow basis, two of the five firms ended up being cheaper than it, while three of the five ended up being cheaper on an EV to EBITDA basis.

Company	Price / Earnings	Price / Operating Cash Flow	EV / EBITDA
Stepan Company	46.0	10.5	13.2
Minerals Technologies (MTX)	28.2	10.4	12.1
Ingevity Corp (NGVT)	13.8	8.1	40.5
Sensient Technologies Corp (SXT)	35.1	17.0	17.8
Axalta Coating Systems (AXTA)	31.1	11.6	12.4
Innospec Inc. (IOSP)	20.5	11.4	12.6

Click to enlarge

Takeaway

All things considered, Stepan Company has been on a rough road. This is quite discouraging. Having said that, the company is showing signs of progress. Cost cutting initiatives, combined with changing industry conditions, are clearly helping on the bottom line. Analysts seem optimistic about upcoming quarterly results. And while shares are not cheap, they certainly aren’t expensive on a cash flow basis. Given these factors, I think that keeping the company rated a ‘hold’ makes the most sense at this time. But I wouldn’t be shocked if, in the not-too-distant future, I end up upgrading the stock.