PQ Group (PQG) surfaced my radar this week after the company announced a sizable divestment. When looking at the company page on Seeking Alpha I have noticed no coverage on the company except an old article which I had written at the time of the IPO, three years ago in September 2017.
My cautious tone has played out to a great extent and while I see appeal increasing a bit amidst deleveraging and much more modest valuations, the situation is still not compelling enough to jump aboard.
Let’s Go Back
When I looked at the public offering of PQ Group in September 2017, I concluded it was a ”no-go” despite a discount provided at the time of the offering.
At the time PQ was a provider of catalysts, specialty materials and chemical products. The company claims that its solutions are used to benefit the environment and for personal safety reasons, which means that the business could be well-positioned to benefit from greater focus on sustainable operations.
The company was a global business with 70 facilities, catering 4,000 customers across the world, although the majority of sales are generated in North America.
The company went public at $17.50 per share in 2017, far below the midpoint of the preliminary offering range at $22 per share. At the reduced offering price, equity was valued at $2.2 billion, although the company had taken on quite some debt as well. In fact, net debt stood at $2.6 billion, translating into a low 5 times leverage multiple in relation to reported adjusted EBITDA.
The company generated $1.4 billion in sales in 2016 on which it reported adjusted EBITDA of $421 million. The steep interest bill made that the company was not reporting any net profits at all, although the retirement of expensive debt and some operational improvements should allow for some earnings to be reported. Based on the deleveraging and pricing in some improvements, I anticipated that the company could post earnings at a rate of around half a dollar per share.
This did not translate into an appealing situation in my book as the company was not really growing, was trading at a high earnings multiple, leverage was high and the company was relying heavily on adjusted metrics.
I am very glad that I held a neutral to very cautious stance at the time of the offering, as shares have been trading between $14 and $18 per share since the offering in both 2018 and 2019.
For the year 2017 the company ended up posting sales of $1.47 billion with adjusted EBITDA reported at $453 million, as the company reported adjusted earnings of $0.52 per share, in line with my expectations at the time of the offering. For the year 2018, as reported early 2019 of course, further improvements were delivered upon. Revenues rose to $1.61 billion although the improvement in adjusted EBITDA was much more modest to just $464 million.
Adjusted earnings improved to $0.87 per share, translating into market multiples, as there were many adjustments to the earnings numbers, including restructuring charges, extinguishment costs, amortization charges, LIFO expense, stock-based compensation expenses, etc.
The 2019 results revealed modest sales declines with sales reported at $1.57 billion, although adjusted earnings per share rose slightly to $0.92 per share. Net debt has been cut to little over $1.8 billion and as adjusted EBITDA improved a little to $474 million, leverage ratios had fallen a bit to 3.9 times.
Shares had fallen to $10 amidst the initial Covid-19 reaction. With 135 million shares outstanding and shares trading at $11 currently, the market capitalization stands around $1.5 billion, for an enterprise value of $3.3 billion. Needless to say that this is very disappointing, after the company was valued at nearly $5 billion at the time of the public offering.
Note that the impact of Covid-19 has been mixed with automotive related markets hit hard of course, offset in part by greater demand for certain performance materials, related to more demand for personal care, detergents and cleaning products, among others. Following the second quarter results, the company guided for sales around $1.45 billion for the year with adjusted EBITDA seen at $410-$425 million.
This indicates that the impact to this year’s results is somewhat modest with net debt flattish around $1.8 billion, as the anticipated declines in EBITDA makes that leverage ratios will increase to 4.5 times again.
A Big Deal!
Investors reacted upbeat to a big divestment being announced mid-October, with shares up 14% to nearly $13 as the company will divest its Performance Materials business in a $650 million deal.
The deal is driven by focus on higher growth and higher margin Catalyst and Refining Service business. The company will use the non-quantified after-tax proceeds to reduce debt by $460 million, while paying a $250 million special dividend, equal to $1.84 per share. The company is furthermore launching a strategic review of the alternatives for the Performance Chemicals business.
So how good is this sales price? With a current enterprise value of $3.3 billion the overall company is valued around 2.1 times sales reported in 2019 and about 7.0 times EBITDA. The $650 million deal was welcomed by investors as the $363 million revenue contribution of the segment reveals a 1.8 times sales multiple being applied. The $77 million EBITDA contribution reveals an 8.5 times multiple has been paid for this lower margin segment, quite a bit above the valuation applied to the overall company at these levels.
Based on the numbers we can deconstruct the implications of the deal to some extent, as I will assume $600 million in net proceeds (being a real estimate). With net debt down to about $1.35 billion, we have to recognize that EBITDA will fall to about $400 million on a pro-forma basis (compared to 2019), resulting in a 3.4 times leverage ratio based on the 2019 performance.
With $77 million in EBITDA leaving the door, I would assume some $5 million in corporate cost overhead should be cut as well. Assuming a 5% cost of debt on $460 million in debt reduction leaves a $23 million reduction in interest expenses. I furthermore peg the depreciation expense at around $30 million, assuming an equal relative depreciation expense across all segments.
If this is correct, earnings before tax will fall by about 420 million. After tax, that reveals about $0.12 per share deleverage, leaving about $0.80 per share based on adjusted earnings on the back of the 2019 performance.
Based on that valuation, multiples come in at 16-17 times earnings at $13. This however is based on the 2019 performance, on the back of adjusted earnings numbers, while leverage ratios remain quite high. The other potential has to come from the strategic review of the Performance Chemicals business as this business was responsible for 43% of sales last year, although it has lower margins. A bit concerning for the long run is that the remaining refining services and catalysts business thrive on fossil fuels and perhaps have a worse long term growth outlook than the business being divested or planned to be divested.
While the stock will certainly attract quite some interest from investors given the upcoming special dividend of $1.84 per share, I fail to see great long term potential amidst secular headwinds from the remaining business, reliance on adjusted metrics and still quite some debt appearing on the balance sheet. That said, the valuation looks more interesting than it has done since the IPO.
Nonetheless, I feel that this is quite a mediocre business and investing in cheap stock for the cheapness argument alone, is never a great reason, as I see no reason to start initiating a position here and now.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.