Improved Operational Efficiency is Renewing Faith in Stepan’s Future

Summary

SCL quarterly earnings per share have gone up to $1.09 in Q3 2015, which is the highest in the last five years.

Improved operational efficiency and overall lower operating expenses contributed to the higher earnings

SCL Q3 2015 return on equity has jumped to 18.04%, an 8.75 percentage point improvement compared to the same quarter last year.

Two of the main product lines of SCL, Surfactant and Polymer contributed to increased operating income, which grew by 96% and 35, respectively, but a strong Dollar compared to the Euro and Brazilian Real translated into lower revenue on the book.

Global Hunter Securities currently have a $56 price target for SCL, giving it an additional 6.5% upside potential.

Company Overview

Headquartered in Northfield, Illinois, Stepan Company (NYSE:SCL) has been manufacturing basic and intermediate chemicals for over 8 decades. Stepan Company mainly produces three types of chemicals, surfactants, polymers and other specialty products.

Stepan Company is one of the largest manufacturers of surfactants in the world, which is a key ingredient in various consumer and industrial cleaning products. Its polymer product line includes polyurethane polyols, polyester resins, phthalic anhydride (P.A.), and specialty polyurethane foam systems. Some of these chemicals are used in making rigid foams for thermal insulation. In the specialty segment, Stepan Company makes various specialty chemicals to meet individual customer needs. Some of the examples of specialty products include flavors, emulsifiers and solubilizers used in the food and pharmaceutical industries.

Stepan Company operates a total 17 ISO 9001:2000 certified manufacturing plants in 12 countries throughout North and South America, Europe and Asia.

Analysis of Q3 2015 Financial Results

SCL price revenue

Figure 1: Stepan Company’s Q3 2015 Revenue Declined by 9.65% Compared to Q3 2014

On October 21, 2015, Stepan Company released its Q3 2015 financial results. In our list of concerns, the first item was the revenue. Stepan Company’s revenue has had some major swings since 2011. But, the quarterly revenue mostly fluctuated between $425 million to $500 million. In Q3 2015, it came out at $444.01 million, representing a 9.65% decline compared to the same quarter last year.

EBIDTA EPS
Figure 2: Stepan Company Q3 2015 EPS Came Out at $1.09, Highest in the Last Five Years

Along with the revenue, Stepan Company’s EBITDA has also gone down to $38.79 million. However, as the operating expenses continued to go down over the last few quarters, quarterly earnings per share ((EPS)) has gone up to $1.09, which is the highest in the last five years.

Although the revenue and EBITDA have slightly gone down compared to Q2 2015, on a Year-to-Date ((YTD)) basis, revenue is still up around 56.67%, which is still pretty good.

As the EPS growth came despite a drop in revenue, it indicates an improvement in internal efficiency of the company, which is a more important factor for an 83 year old company compared to a 2 year old startup.

As a result of this improved efficiency, Stepan Company’s Q3 2015 return on equity ((ROI)) has jumped to 18.04%. Compared to the Q3 2014 ROE of 9.29%, that is an 8.75 percentage point improvement within a year.

ROE TTM
Figure 3: Stepan Company’s ROE ((TTM)) Has Finally Started to Go Up after Declining for Four Years

The latest improvement in the internal efficiency in the company has helped it to finally reverse its declining ROE ((TTM)) trend as well, which has been the name of the game for last four years.

Revenue Growth Undermined by “Other” Factors

Of course, full credit goes to the management for improving the asset utilization of the company that helped drive its growth in North American market in the last year or so. Two of its main product lines, Surfactant and Polymer contributed to increasing operating income, 96% and 35% respectively.

Stepan Company saw improved sales performance in Latin America and Europe. However, the strong valuation of the Dollar against the Euro over the last quarter was one of the main reasons its revenue growth came out much lower on the books. Otherwise the revenue would have been much higher because of its growth in the international markets.

Moreover, effective tax rate has gone up to 28% compared to 27% during the last year, explained the VP and CFO of Stepan Company, Scott Beamer, during the earnings call.

Conclusion

Although the revenue has been declining, according to Cube Capital, Stepan Company’s revenue has been significantly higher compared to the peer median, which is the median revenue of its closest competitors. Moreover, its earnings history also indicates a higher level of earnings compared to the same group of competitors in the industry it operates in.

The highest quarterly EPS in the last five years has encouraged Stepan Company Board of Directors to declare a $0.19 per share quarterly cash dividend on Stepan’s common stock, which is a 5.6% increase.

Global Hunter Securities currently have a $56 price target for Stepan Company’s common stocks. As of writing this analysis, it still offers investors a 6.5% upside potential based on the October 23, 2015, closing price of $52.59 per share.

We must remember that Stepan Company’s products are mostly commodities and they hardly sell any differentiated products. Which magnifies the significance of these improved, but basic financial metrics, which the management delivered despite a drop in top line growth over the last 12-month period. We believe the upside potential of this company is much higher than the price target((s)) set by some of the mainstream equity research firms.