Our first idea today is a global construction materials company that is expected to grow by 109% next year, and has the makings of a good turnaround. Our second recommendation is profit-taking on a previous pick.
GCP Applied Technologies Inc. (GCP)
From The Turnaround Letter
GCP Applied Technologies is a global construction materials company. Its largest segment, Specialty Construction Chemicals (about 57% of revenues), produces additives for concrete and cement that improve their performance. The Specialty Building Materials segment (about 43% of revenues) produces waterproofing membranes, roofing under-layments and a range of other materials for new construction and renovations that protect buildings from water, vapor, fire, and other types of damage.
About half of GCP’s revenues are generated from outside of the United States. Based in Cambridge, Massachusetts, GCP was formed within W. R. Grace & Company in 2015 and spun off to shareholders in February 2016. The company’s stock price rose steadily after the spin-off, more than doubling to over $33 by March 2018, due to GCP’s bright prospects, undervaluation, and potential for a breakup. Reflecting this sentiment, when GCP agreed to sell its Darex Packaging Technologies business to German company Henkel for $1.1 billion in March 2017, the shares jumped 25%.
However, the company’s remaining operations went on to produce disappointing results, with quarterly revenues and earnings regularly missing analysts’ estimates. At this point, GCP appears to be poorly managed: revenue growth has lagged the industry, expenses remain bloated, a steady stream of restructuring plans have produced no lasting improvements, and the board of directors has been plagued by problematic interlocking relationships that curbed its accountability and led to excessive compensation and other governance issues.
One indication of investor frustration: GCP shares jumped 13% in early 2019 when the company announced a strategic review along with respected and successful activist investor Starboard Value’s initial plans to nominate board members, only to fall sharply when the company later announced that the review would not result in a sale. GCP shares now trade at $17.96, not much higher than the roughly $16 price at the 2016 spinoff.
The GCP situation has the ingredients of an impressive turnaround. First, it has stable revenues in a relevant industry. Its organic sales growth has been flat since 2017, while its products (at least previously) held the #1 or #2 market shares in critical segments within the growing and steadily relevant global construction industry. Second, it has a capable new board of directors with a credible strategy to improve the company’s operations. Starboard Value, which holds a 9% stake, led a successful proxy campaign in which shareholders elected its slate of well-qualified directors to replace eight of GCP’s ten directors earlier in June. GCP has a relatively new CEO (Randy Dearth) who joined as president in July 2019. We anticipate that he will either become more effective or be replaced.
The company’s plan going forward includes detailed steps to boost organic revenue growth, expand margins by up to six percentage points, and rebuild product innovation effectiveness. Another possible outcome is a breakup and sale of the company. We note that industrial firm Standard Industries holds a 17% stake; perhaps because it would like to acquire the membranes business to add to its line.
Additionally, although the company is operating well below par, it remains profitable and generates free cash flow. The balance sheet has only a modest $348 million in debt, almost fully offset by $320 million in cash. Lastly, GCP shares are significantly undervalued. In a turnaround or sale, we believe the company is worth at least $28, providing investors with an attractive potential return.
We recommend the purchase of GCP Applied Technologies (GCP) shares with a $28 price target.
George Putnam III, The Turnaround Letter, turnaroundletter.com, 617-573-9550, July 2020