In what is likely to become a recurring theme with industrial stocks during earnings season, galvanizing and electrical products company AZZ Incorporated (AZZ -0.17%) reported results affected by weaker end demand. On the other hand, AZZ managed to produce double-digit EPS and net income growth in the third quarter while delivering an impressive operating margin increase. Let's take a look at the details of a solid quarter.
AZZ INCORPORATED'S GALVANIZING OPERATIONS. SOURCE: AZZ INCORPORATED.
AZZ Incorporated results: The raw numbers
Starting with the headline numbers from the third quarter:
- Revenue increased 7.8% to $242.4 million.
- Gross margin fell to 25.8% compared with 27% in last year's third quarter, primarily due to the negative margin of integrating U.S. Galvanizing--an acquisition made in 2015
- Selling, general, and administrative (SGA) expenses fell to 10.7% of sales, compared with 12.4% in the same period last year.
- Operating margin increased to 15%, compared with 14.6% in last year's third quarter.
- Pre-tax income increased 14% to $32.7 million in the quarter, and diluted EPS of $0.91 represented an 18.1% increase compared to the same period last year.
Turning to the guidance:
- The full-year fiscal 2016 revenue guidance range lowered to a range of $890 million-$915 million, from previous guidance of $900 million-$940 million.
- The full-year EPS guidance range lowered to a range of $2.90-$3.10, from previous guidance of $2.85-$3.30.
What happened with AZZ Incorporated this quarter
It helps to break up AZZ's results by segment:
| Segment | Sales ($ millions) | Change | Operating Income ($ millions) | Change | Margin | Change (bp) |
|---|---|---|---|---|---|---|
| Energy | 136 | 4.6% | 18.8 | 14.3% | 13.9% | 120 |
| Galvanizing | 106.4 | 12.3% | 24.3 | 4.8% | 22.8% | (160) |
| Total | 242.4 | 7.8% | 36.4 | 10.6% | 15% | 40 |
SOURCE: AZZ INCORPORATED PRESENTATIONS. BP = BASIS POINTS, WHERE 100 BP EQUALS 1%.
In short, AZZ reported an impressive revenue increase, although $11.6 million of the $17.6 million increase was primarily due to the U.S. Galvanizing acquisition. No matter, as both segments, energy and galvanizing, reported revenue expansion.
The reduction in SGA expense was "primarily attributable to our companywide focus on cost efficiency and our prior year realignment efforts," according to CFO Paul Fehlman on the earnings call.
Galvanizing
On a segmental basis, the galvanizing acquisition clearly cost the company some gross margin, but Fehlman outlined his expectation that the acquired U.S. Galvanizing gross margin would "reach our normalized galvanizing margins over time." However, the galvanizing segment also suffered some pricing and volume headwinds in the quarter.
Speaking about the galvanizing segment on the earnings call, CEO Tom Ferguson disclosed: "While our volume overall is up, we have had to give some on pricing to sustain that volume. And we will probably continue to do that to a point." It's something to look out for in future quarters. Ferguson also mentioned a "moderate decline" in volume from customers affected by lower oil prices.
Energy
Turning to the energy segment, the operating-margin expansion (see the preceding table) and revenue increase is all the more impressive considering a couple of negative factors:
- Management reported "mixed market conditions" in the sector.
- The segment didn't "ship any more of the long-delayed Westinghouse nuclear project orders during the third quarter," according to Ferguson on the earnings call.
No matter, as the energy segment overcame these headwinds. Ferguson argued that U.S. electric utility spending was stable and discussed international growth opportunities for Energy's products. Moreover, he outlined "seeing order growth on domestic utility infrastructure investments."
Looking ahead
In future quarters, investors should look out for a recovery in Galvanizing margin, as the U.S. Galvanizing acquisition beds in. In addition, Ferguson expects delayed nuclear orders to be "shipping by our fiscal year end" in the Energy segment.
The lowering of the midpoint of EPS and revenue guidance, along with commentary on pricing concessions in Galvanizing, is a disappointment, but elsewhere AZZ's results show a solid quarter of execution.
