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DMC Global Lost Market Share, But Prepares To Wrest It Back

DMC Global Is Ready To Fight It Out

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DMC Global’s (BOOM) top line and margin deteriorated considerably in Q2 as the customers opted for the cheaper component perforating gun providers. Low volume and capacity utilization of the production facilities led to cost under-absorption, which put enormous pressure on the operating margin in Q2. As I do not see the company reclaiming market share in Q3, the stability in the backlog and the DUC well count resilience signals a potential recovery in the medium term.

I think a technologically superior product suite related to BOOM’s integrated perforating guns and the automated shaped charge will continue to command competitive advantages in the industry. The company’s balance sheet is strong. However, in the current environment, when the credit market is squeezed, it might want to increase free cash flows to improve investor sentiment. I expect its revenues and margin to recover by Q4. So, expect the stock price to stay muted in the short term before it starts moving up by the end of the year.

Looking Through The Industry Indicators

The energy industry threw up a mixed signal in Q2 2020, while the timing of recovery remains uncertain. The crude oil price, following a crash in Q1, recovered strongly in Q2 (91% up) and has held steady since then. The U.S. rig count, on the other hand, lagged with a 64% decline in Q2. The completed wells in the EIA-designated key shales exhibited considerable weakness (down by 73% in Q2).

However, the drilled but uncompleted wells (or DUCs) have been resilient, because the producers figure they can start producing in these wells at a relatively low cost. Nonetheless, the excess capacity of the OFS equipment kept pricing for oilfield equipment services low. For BOOM, the fall in completions well count has had a significant effect, and it would take several months for the industry to attain the peak.

The current challenges in the industry include the demand weakness following COVID-19, an oversupply of equipment, and leveraged balance sheets among the energy producers and equipment makers. During the current downturn, many customers chose to invest in assembled perforating guns because they offered pricing discounts and were more readily available. While this is not unexpected in a short-cycled volatile market, BOOM’s management continues to believe in the long-term value proposition of its premier DynaEnergetics product.

The company’s premier product, the integrated or pre-assembled guns, have competitive advantages over the assembled perforating gun component providers, including Core Laboratories (CLB), Hunting PLC (OTCPK:HNTIF) and Oil States International (OIS). You may read more about the company’s business model in my previous article here.

In the composite metal business, DMC Global will see increased applications, despite the project delays following the pandemic. It is also pursuing a wide range of order opportunities in the downstream petrochemical sector and new end markets.

New Offerings

Of late, the DynaStage (or DS) product family and the introduction of the intrinsically safe initiating systems (or IS2) have become BOOM’s critical growth drivers. Expanding on its core integrated perforating sun systems offerings, it has introduced DS Echo, which is a factory-assembled perforating system for the emerging re-frac market. DS MicroSet is used for isolating an individual stage in a well, and DS Liberator, which allows the disengagement process from the perforating string.

Cost-Reduction Initiatives

In Q2 2020, BOOM’s gross margin and EBITDA came under severe pressure. Lower DynaEnergetics sales volume led to significant under-absorption of fixed overhead and research and development expenses. Add to that low capacity utilization of the production facilities, and it explains the negative EBITDA in Q2. So, a severe cost curtailment has become necessary for the company.

In April 2020, DMC announced several measures to streamline its cost structure and strengthen its balance sheet. These actions included reducing the workforce by 32%, cutting selling, general and administrative (or SG&A) expenses by 25%, and reducing the FY2020 capex budget by 50%. On top of that, the company suspended the quarterly dividend to improve cash flows.

How Did The Segments Perform In Q2?

North America’s abrupt downturn in unconventional well completion activity severely affected the DynaEnergetics segment results in Q2 2020. So, revenues in this segment decreased by 55.6% in Q2 2020 compared to Q1 2020. The segment adjusted EBITDA also turned negative in Q2 2020. During the quarter, low capacity utilization in the company’s manufacturing facilities resulted in an excess capacity charge, which adversely affected the margin.

Revenues from the NobelClad segment were relatively resilient, decreasing by 3.8% in Q2 2020 compared to a quarter ago. The segment adjusted EBITDA increased by 29% during the same period. It reduced salaries and wages, variable bonuses, and other compensation-related costs, which benefited the segment margin.

NobelClad’s backlog recovered in the two consecutive quarters until Q2, after falling for the previous three quarters. At the end of Q2 2020, the backlog increased by 4% compared to Q1 2020. Investors may note that the segment demand is typically cyclical, driven by maintenance and retrofit projects. So, we can expect the segment top line and the margin to improve in 2H 2020.

Q3 2020 Guidance

DMC Global expects to improve most of its performance parameters in Q3. In Q3, its management expects revenues for the DynaEnergetics segment to increase by 21% (at the guidance midpoint) compared to Q2. In the NobelClad segment, revenues can decrease by 3.8% sequentially. Gross margin can improve by 670 basis points. With lower SG&A costs, the company’s EBITDA can turn marginally positive, while the company expects a slightly favorable net cash position by the end of Q3.

Linear Regression-Based Revenue Forecast

I have observed a regression equation based on the historical relationship among the crude oil price, the completed well count in the key unconventional shales, and BOOM’s reported revenues for the past 16 quarters. I think that the shorter trend factor will initially play a more significant role, but will gradually lose importance. So, I expect its revenues to increase in the next quarter, a decline in Q4, and then reverse the trend and increase afterward in the following couple of quarters.

In the Monte Carlo simulation, after 10,000 iterations, I find that the maximum frequency ranges between $60 million and $82 million. The current revenue falls short of this range. Investors, however, should note that this is only an academic exercise.

Cash Flows And Balance Sheet

In 1H 2020, BOOM’s cash flow from operations (or CFO) declined by 52% compared to a year ago due primarily to lower revenues during this period. During the same period, its capex was 54% lower. Despite that, free cash flow (or FCF) fell significantly in 1H 2020. I think during Q3 and Q4, the company will draw from the inventory, at which point the working capital requirement will come down, which will improve its cash flows.

BOOM’s debt-to-equity ratio (0.07x) is significantly lower than its peers’ (Halliburton (NYSE:HAL), OIS, and The Gorman-Rupp Co. (NYSE:GRC)) average of 0.57x as of June 30, 2020. With the available liquidity of $67 million (cash balance and revolving credit facility), and with only ~$13 million in total debt, the company does not have any financial risk.

What Does The Relative Valuation Say?

BOOM is currently trading at an EV-to-adjusted EBITDA multiple of 9.5x. Based on sell-side analysts’ estimates, the forward EV/EBITDA multiple is significantly higher, which implies a much lower EBITDA in the next four quarters. The stock is currently trading at a discount to its average (14x) between FY2015 and now. I have used estimates provided by Seeking Alpha in this analysis.

Analyst Rating

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According to data provided by Seeking Alpha, two sell-side analysts rated BOOM a “buy” in July (includes “very bullish”), while one of the sell-side analysts rated it a “hold.” None rated it a “sell.” The analysts’ target price is $31.67, which at the current price, yields ~7% returns.

According to Seeking Alpha’s Quant Rating, BOOM currently receives a “Very Bearish” rating. While the ratings are moderately high on profitability and momentum criteria, they are low on growth, revisions, and value.

What’s The Take On BOOM?

The steep fall in completions activity has affected BOOM’s performance considerably in the past three quarters. In a tight market where capital is scarce, the cheaper component perforating gun providers have temporarily taken away the market share. Although I do not see the company reclaiming market share in Q3, the energy price stability and the DUC well count resilience signal the arrival of better days for the company in the medium term.

The temporary setback has not discouraged DMC Global’s management from offering new products from its DynaEnergetics suite of products. Its integrated perforating guns will continue to command competitive advantages in the perforating gun systems and automated shaped charge manufacturing. I expect the pricing and margin to recover by Q4. The company’s balance sheet is strong, which is a significant advantage over its competitors. However, an improvement in working capital would become essential in improving cash flow operations and producing positive free cash flows. In the current environment, when the credit market is squeezed, a strong FCF drives investor sentiment. Overall, the stock remains a medium-term play.

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.

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