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Friday, September 4, 1998
Zoltek Companies
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Phone: 314-291-5110
Price (9/3/98): $11 23/32
HOW DID IT FIND TROUBLE?
Good thing Zoltek has a role in making airbags because the stock has crashed.
A year ago, this carbon and acrylic fiber manufacturer had bolted to $66, a 900% gain over the previous two years. Though revenues depended on European textile markets, the company expected huge growth from supplying sexy, high-margin carbon fiber for new uses beyond the aerospace market -- say, for graphite golf clubs. Since last September, though, the stock has been sliced for a 80% loss.
While Asia's troubles have cut into sales to electronics manufacturers and pressured prices of acrylic fiber, Zoltek has also ramped up capacity for sales that haven't materialized. New customers are still testing and qualifying the carbon fiber. So as fast-growing sales finally declined, inventories have soared.
Third quarter results highlight the problems. Sales plunged 18% to $18.9 million due to a 20% drop in sales of acrylic fibers and a 13% dip in carbon fiber revenues. That pushed operating income down 33%. Add in an extra tax hit given that net operating loss carryforwards (NOLs) were exhausted in the second quarter, and net income plunged 48%, resulting in earnings of $0.10 per share versus $0.19 a year ago.
As if that wasn't bad enough, Zoltek also botched its third quarter earnings release. The Wall Street Journal reported August 19 that the SEC was investigating allegations that the company gave premature warning of the third quarter shortfall to its underwriter, Pauli & Co., which is said to have then contacted a major holder. SEC Chair Arthur Levitt has said selective disclosure is a problem akin to insider trading.
Zoltek claims it's not guilty as charged. Management said a power outage at its PR firm was behind the gaffe, but it has not publicly disclosed the firm involved. Even more troubling, Chair/CEO Zsolt Rumy called Pauli & Co. "a bunch of snakes." Also, CFO Daniel Greenwell apparently refused to answer the Journal reporter's questions regarding precisely when Zoltek faxed the earnings release. "I don't owe that to you," Greenwell is quoted as saying.
Combine poor results with what looks like an arrogant disregard for average shareowners, and you've got a recipe for trouble.
BUSINESS DESCRIPTION
Zoltek is based in St. Louis, Missouri, but it has major manufacturing operations in Hungary and Abilene, Texas. While about 73% of revenue comes from the sale of acrylic fibers used in clothes and carpets, the company aims to grow sales by producing carbon fiber for new markets by becoming the low-cost provider.
Zoltek has exclusive, long-term deals to supply carbon fiber to BF Goodrich <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GR)") else Response.Write("(NYSE: GR)") end if %> for use in carbon-carbon brakes and to TRW <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRW)") else Response.Write("(NYSE: TRW)") end if %> for use in pyrotechnic automobile airbags. Carbon fiber is also used in electronics products, where the fiber dissipates static electricity and heat.
Strong, stiff, but lightweight, carbon fiber may find increased usage in a number of products: shipping containers, vehicle drive shafts, wrapping and reinforcement for concrete structures, pressurized tanks, and even sports equipment.
The December 1995 acquisition of the Hungarian manufacturer of acrylic and nylon products now called Zoltek Rt. gave the company access to the technology to produce the raw material that accounts for half the cost of carbon fiber. Zoltek currently acquires most of this raw material from Courtaulds <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: COU)") else Response.Write("(AMEX: COU)") end if %>, the world's only merchant supplier of this product.
In the fourth quarter of FY97, Zoltek added five new manufacturing lines capable of generating a total rated capacity of five million pounds of fiber annually. Eleven new lines will be constructed this fiscal year, with $22.5 million spent so far as part of a massive capital spending campaign that will run into FY99.
Insiders own 35% of the stock, with most held by CEO Rumy.
FINANCIAL FACTS
Income Statement
12-month sales: $86.5 million
12-month income: $12.4 million
12-month EPS: $0.75
Profit Margin: 14.3%
Market Cap: $193.2 million
Balance Sheet
Cash: $35.2 million
Current Assets: $72.0 million
Current Liabilities: $15.1 million
Long-term Debt: $3.7 million
Ratios
Price-to-earnings: 15.6
Price-to-sales: 2.2
HOW COULD YOU HAVE SEEN IT COMING?
Investors expect companies to beat analysts' earnings estimates -- often substantially -- because analysts often rely on the firm's own guidance. When a company misses projections, something's usually amiss.
Here is Zoltek's sequential performance relative to expectations over the last four quarters, according to Zacks: +4.4%, flat, -4.6%, -37.5%. Investors can avoid trouble by learning to extrapolate potential trends from the first couple of data points. This extrapolation process might have been helped by the news in February that CEO Rumy sold 100,000 shares for around $36, or about half of what shares traded at just a few months earlier.
While price deflation and weak demand resulting from Asia's troubles has hurt Zoltek, the larger problem is that the company has ramped production capacity (and thus fixed costs) without having new customers nailed down. Meanwhile, inventories have accumulated.
A sequential sales decline in the fourth quarter of FY97 to $22.8 million from $22.9 million was problematic given that inventories simultaneously jumped to $12.5 million from $11.9 million. This divergence pointed to underlying troubles and suggested a potential short-term inflection point.
Sales continued sputtering, registering a year-over-year decline in the March quarter. Even worse, inventories have continued higher, rising to $16.3 million in the first quarter, then to $16.7 million in the second quarter, and finally to $20.7 million in the June quarter. Again, the early data pointed to a possibly ugly trend.
WHERE TO FROM HERE?
Insiders have been buying since the disappointing third quarter earnings report (a positive sign) despite the fact that estimates have been cut substantially to $0.71 per share in FY98 ending in September and $0.91 per share for FY99.
The stock now trades at 16.5 times forward earnings estimates, a number that might look cheap given Zoltek's 93% annual earnings growth from FY95 through FY97. Yet earnings have stalled, and the questions asked during the stock's decline remain unanswered. For starters, why is the company still adding capacity when its latest production lines are apparently dormant?
Also, short interest recently stood at 3.4 million shares, a hefty amount indicating that professional short-sellers have piled on. Although some investors believe short-selling is positive in that it creates future buying pressure, academic research suggests that heavily shorted shares often have further to fall. The shorts aren't likely to back off until Zoltek's business improves.
Enhanced profits look possible given that, despite pricing pressure, gross margins in the acrylic fiber line actually rose to 27.8% last quarter versus 26.2% in the year ago period thanks to increased productivity. So rebounding sales even in the ho-hum acrylics business would prove more profitable.
On the other hand, management's public explanation for the earnings release debacle seems inadequate. That's a problem because, in general, individuals should be cautious about investing in any company that doesn't show an absolute commitment to the equitable disclosure of material information. Disclosure practices can say a lot about management's basic appreciation for what it means to run a public company.
-- Louis Corrigan
([email protected])
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