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One of the key players in an industry with low margins and low global growth, NewMarket Corporation (NYSE: NEU ) has done remarkably well increasing its revenue despite an uncertain economy. Recently, though, certain numbers from its first quarter earnings report have given investors cause to revisit their investment theories to see if NewMarket can continue its climb. While revenue from its primary division, Petroleum Additives, rose 2.8% to $574 million from $558 million, NewMarket posted a loss of nearly $10 million. Coming off such a strong 2013 for the company, the question that arises now is what happened in the first quarter, and should this be cause for concern going forward?
The end of 2013 seemed like another successful year for the specialty chemical company. Net income came to a total of $264.72 million, up from 2012's year-end of $239.53 million, and the operating profit from the petroleum additives segment increased nearly $3 million from 2012 to 2013. Products shipped in 2013 rose 3.7% from 2012 levels, and the operating profit margin for the lubricant and fuel additive product lines stayed relatively stable at 16.5%.
In the earnings call on April 24, CFO David Fiorenza attempted to shed a little light on the company's current position in 2014, and tried to address issues that might make investors skittish. Even accepting the amount from an interest rate swap that had gone against them and that Q1 of 2013 included revenues from the now-sold real estate operations from the building of NewMarket's new corporate headquarters, income from Q1 would have only been $58.9 million, or $4.54 per share.
The nearly $6.8 million difference was explained by management to be a combination of exchange rate loss, product mix, and income taxes as a result of R&D spending. In a global industry with four major players whose backers include oil companies and the power of the Buffett empire at Berkshire Hathaway, $6.8 million may not seem like much. However, it tells us significantly more about what is keeping management up at night, and what plans they have to keep their current winning streak alive.
Asia or bust...literally?
Newmarket explained that although a global business, it takes no steps to actively hedge against currency risk, reaping the rewards when it works in their favor and taking the losses when it moves against them. While there doesn't seem to be any threat to North America being NewMarket's primary market (accounting for 40% of revenue), the growth in demand for petroleum additives as well as NewMarket's continued expansion into Asia should at least begin to raise the question of whether management needs to revisit the issue.
NewMarket looks to be playing the long game to develop its brand in Asia, building a research and development plan in Japan in 2008, acquiring numerous facilities and customers through its 2010 acquisition of Polartech and a manufacturing facility in Singapore in 2010, and the building of a $100 million dollar manufacturing facility in Singapore already underway, estimated to be completed 2015.
While the last few years have shown this to be a positive move for NewMarket, should a company that is so heavily invested in building an international brand really have no strategy about how to deal with foreign exchange rates? Well, the numbers show that no, you don't necessarily need to have a strategy. In 2013, Newmarket Corp had the benefit of having the exchange rate work to its favor, reaping $5 million just from a favorable currency exchange. Over time, management believes this to level out and become a zero-sum, but it might be advantageous to begin revisiting those policies to see if it can mitigate how wildly that can throw off its quarterly earnings and allow investors to focus greater on the long-term picture.
Management went on to explain that the petroleum additives industry, and the different products within its product offerings, are based on short-term demand and do not necessarily have a seasonal cycle. While this also explains the building of another manufacturing center in Singapore, it also means that the product demanded and sold in that quarter is often extremely different than the same quarter of the previous year. Mr. Fiorenza remarked on this, stating that, "you may have more demand for a product at one range of probability and less at the other end." Purchasers of petroleum additives, especially within lubrication and fuel additives, buy specific products for specific needs, only replacing them when they run out. Although its recent product mix has been weak, the nature of the industry means that there will be many more profitable purchases in the future, leaving NewMarket poised to deliver future gains through 2014 and into 2015 when customers finally need to reorder.
Finally, NewMarket cited tax issues regarding Research and Development. Referencing earlier earnings calls where they warned investors about this, NewMarket's research and development tax credits from the federal government were not renewed in time for the beginning of 2014 thanks in large part to the government shutdown at the end of 2013, leaving NewMarket to face a corporate tax rate of 31.4% as opposed to the 27.6% from Q1 2013. This change equates to roughly a $3 million impact against NewMarket and its taxable income. With the return to work for furloughed federal employees, this backlog will be reduced, and the ability of NewMarket to take advantage of the tax credits for the remainder of 2014 should be something that will be a key strength of this company and continue for years to come.
Final thoughts: everyone has bad days
NewMarket seems to be making the most of a tough industry. With projections that global demand will grow by only 1% to 2% a year, NewMarket continues to do well such as 6% shipment growth in Q1 2014 and 2.8% revenue growth average for its petroleum additives, even in a bad quarter. Although these margins are thin and growth seems slow, NewMarket continues to do well and is using its cash not only to develop new manufacturing facilities its target locations and demographics, but also to repurchase 232,000 shares for a rough total of $81 million. This clearly shows that NewMarket's management has a clear and realistic vision for the future and is willing to position themselves accordingly for the long haul.
NewMarket management seems to have a clear view of where they want to position themselves and are making moves to achieve that goal. Everyone is allowed to have a bad day every now and then, even corporations.
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