After a difficult 2014 in which the company underperformed the S&P 500 index by nearly 14%, AZZ (NYSE:AZZ) is ahead of the index by more than 8% on a year-to-date basis. Essentially, AZZ's management has addressed a number of issues that plagued the company last year, and the market is warming to its plan to expand its steel galvanizing operations. In this context, let's take a look at its recent first-quarter results and what they indicate for the company's prospects.

AZZ Chart

AZZ data by YCharts.

AZZ results
Overall revenue grew 5.9% compared to last year and operating income increased 18.9% to $32.9 million, largely driven by margin expansion in its energy segment. The company reports out of two segments, both of which reported solid underlying growth in the quarter. Energy generates more revenue, but Galvanizing Services produces more profits due to its higher margin profile.

SegmentRevenueRevenue GrowthOperating IncomeOperating Income GrowthMargin Improvement (bp)
Energy  137  5% 18 31.5% 260
Galvanizing Services 91.9 7.3% 22.1 0.4% (170)

Source: AZZ presentations; all figures in millions of U.S. dollars unless stated. Bp = basis points, where 100 bp is 1%. 

In addition, full-year revenue and earnings guidance was increased mainly as a result of the acquisition of U.S. Galvanizing from Trinity Industries, something that management feels will add around $0.10 to EPS in 2016. A summary of the guidance change:

  • Full-year 2016 revenue expected in the range of $900 million to $940 million compared to previous guidance of $875 million to $925 million
  • Full-year 2016 EPS expected in the range of $2.85 to $3.30 compared to previous guidance of $2.75 to 3.25

If you are wondering why the top end of the updated EPS guidance was onlyraised by $0.05, here is CEO Tom Ferguson's response when pressed on the issue during the earnings call:

In terms of the top side, we are still just -- even though we only have 5% exposure from our energy businesses to the oil markets, our rig activity being really low, our concern is, does it have any fallout impact to our galvanizing businesses as we see some of the petrochemical, refinery, and other projects affected.

Energy segment
Its legacy Energy segment provides products and services to support industrial, nuclear, and electrical applications. As Ferguson outlined in the passage above, AZZ has exposure to the oil and gas industry, and management was previously forced to reduce earnings expectations for 2015 as a consequence of the fallout from lower energy prices.

In addition, some of its large nuclear projects saw contracts delayed last year, with the expectation that they would be pushed out into the current year's earnings. This is obviously an area of concern for investors, but on the earnings call, Ferguson gave some positive feedback on the issue: "The orders are very active, and I think the customers are showing the intent to take delivery later on this year. I'd still position it in the latter half of the year, third and fourth quarters."

Undoubtedly the most impressive part of the results was the 260 basis-point margin increase in the energy segment, and CFO Paul Fehlman argued on the earnings call, "We'll be getting into low teens to mid teens on a normalized basis over the long run there."

Galvanizing Services
Don't be fooled by the 170 basis-point reduction in operating income outlined in the first table above; in reality the segment had a good quarter. Last year's first quarter contained a $2.4 million benefit from insurance proceeds compared to a $0.3 million benefit in this year's first quarter.

Adjusting for these benefits means that the segment's operating income actually increased 11% and margin increased 80 basis points.

 Metric

Q1 2015

Q1 2016

Operating Income

22,010

22,094

Insurance Proceeds

2,400

300

Adjusted Operating Income

19,610

21,794

Adjusted Margin

22.9%

23.7%

Source: AZZ presentations; all figures in thousands of U.S. dollars and, unless stated, author's analysis.

This is a good result considering that operating income margin at Galvanizing Services took a hit last year due to a combination of issues. For example, in the third quarter, I outlined how margin fell due to increased costs related to an acquisition, the reopening of a plant, and a realignment charge. Fast-forward to the fourth quarter, and galvanizing margin was held back due to severe weather conditions and taking on lower-margin work.

Indeed, the following chart demonstrates the impact on margin last year (I've used the unadjusted figures for the current quarter).

Azz

Source: AZZ presentations.

The good news is that underlying margins have improved and management appears to have worked through most of the issues in the segment.

Looking ahead, the acquisition of U.S. Galvanizing adds six more galvanizing facilities and increases AZZ's network of hot-dip galvanizing facilities to 42. Moreover, the company recently announced a plan to build a galvanizing plant in Reno, Nevada. 

The takeaway
All told, in the Energy segment, investors will be looking for the nuclear push-outs to take place in the second half, and hope that the oil and gas industry stabilizes.

Meanwhile, Galvanizing Services has work to do with the integration of the new U.S. Galvanizing facilities and construction of the Reno facility. So far, so good this year, and provided margins continue increasing, investors can expect more good times in 2015.

Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends AZZ. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.