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OM Group: The Strong Attraction Magnet Manufacturer

The weakness of the European LED market investors bail OM group company. Industrial use of magnet, the battery maker, and specialty chemicals, automotive, aerospace, medical equipment industry, has attracted more than half of its revenue from europe.
Professional battery powered satellite OM. Eric simonsrn / Getty Images
Profitability may cut benefits from cost. More important is, at $3.50 per share of net cash on its balance sheet and free cash flow expected rate of return of 10%, distribution depends largely on how to manage its capital.

Management has been returning cash through dividends and stock buybacks, but the level may be too conservative for some investors. The situation could attract an activist.

The shares are cheap, trading for an enterprise value of six times estimated 2015 earnings before interest, taxes, depreciation, and amortization (Ebitda). Chris Kapsch, who covers OM Group for Topeka Capital Markets, puts fair value 25% higher at $33, based on 7.5 to 8 times estimated Ebitda.

Led by CEO Joseph Scaminace, Cleveland-based OM Group has been dramatically transformed in the past seven years. It has shed its commodity exposure, expanded into higher-margin businesses through acquisitions, and paid off all its debt.

Last year, OM sold its cobalt unit to a mining consortium for $329 million. The business made cobalt-based products for markets including automotive and renewable energy, and in 2012 contributed 25% of OM sales. Due to cobalt’s choppy pricing, earnings were volatile.

The remaining businesses are highly specialized and tied to attractive markets. The company’s magnets are used in automotive systems that lower emissions, and play to the trend of increased electrification in cars. Its batteries power satellites, missiles, and medical devices, including pacemakers and defibrillators. The magnetics and battery divisions account for nearly 70% of sales.

OM also makes specialty chemicals for circuit boards and hard-disk drives in televisions, tablets, and smartphones.

THIS YEAR, OM COULD earn $29 million, or 92 cents a share, on $1 billion in revenue. In 2015, $1.17 a share in profits are expected, reflecting operational improvements.

Earnings aren’t the best performance proxy, however, due to heavy acquisition-related amortization charges. Free cash flow, a better metric, could hit $80 million next year, double this year’s expected level, as management gets a better grip on working capital.

While European markets have hurt business, management is aiming for improvements. The company is cutting headcount and consolidating facilities, in a bid to lift Ebitda margins to 16% in 2017, from the 12% expected this year. Several top managers have been hired to achieve the goal, including a new chief for the magnet business.

In the September quarter, excluding the sale of the cobalt business, revenue was flat from the year-earlier level. Magnet revenue fell 4% on lower volume in Europe and a weaker euro. The division draws 70% of its sales from the region. OM cut its Ebitda guidance for the year, implying more pain ahead in Europe.

Investing in the business and acquisitions are management’s capital-allocation priorities. The company is targeting bolt-on deals of $25 million to $100 million, but isn’t ruling out something larger. Last month, it announced that it is paying $24 million for niche battery-maker Ener-Tek.

In February, OM initiated a dividend, for a current 1.2% yield, and has $51 million remaining on its $100 million buyback program.

OM has targeted a capital structure with debt at one to two times Ebitda, but as Topeka’s Kapsch notes in a report, “Many would argue that two to three times is more appropriate, particularly given interest rates.”

Kapsch says that even if OM ended the year with $25 million in net cash from $107 million at the end of the September quarter, and did a $200 million deal, its balance sheet would be levered at only 1.2 times. Boosting that to 2.5 times could fund nearly $200 million in additional buybacks, equal to about 25% of OM’s stock-market value.

An activist probably would push for more leverage, bigger buybacks, and perhaps even the sale of one or more of OM’s businesses. If an activist were to appear, investors might become more interested in the stock.

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