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KMG Stock Report_PRJ

KMG Stock Report_PRJ

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Published by darkstar777
A stock report that I wrote for KMG Chemicals Inc. in the Fall of 2010.
A stock report that I wrote for KMG Chemicals Inc. in the Fall of 2010.

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Published by: darkstar777 on Apr 13, 2011
Copyright:Attribution Non-commercial

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07/21/2011

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[1]
 
y
 
KMG
has three business segments operating in the samesector (specialized chemicals), but each with their ownmacroeconomic drivers, regional operations, andgeographic market space. In this way,
KMG
candiversify away much of the macro-risk that wouldnormally exist for a company of their size.
y
 
T
he semiconductor market is expected to rebound fromnegative growth over the last five years to +7.8% over the next five years.
T
his coupled with the fact that Intel(the single largest producer of semiconductorsworldwide) represents 10% of 
KMG¶
s electronicchemical sales bodes well for this segment of thecompany. Furthermore the recent acquisition of 
G
eneralChemical
s electronics division will offer noticeableopportunity for expanded market share, primarily inAsia where the company formerly had a very small presence. It is also expected that
KMG¶
s integrationstrategy will realize synergies that will create productionefficiency leading to realized margin growth.
T
his is based on the previous successful acquisitions &integrations of 4 different business units from 2004 to2007.
y
 
KMG
has created significant barriers to entry viafocusing on niche products that are produced by only ahandful of competitors and that require significantapproval/registration processes.
y
 
L
arge to complete market share could allow
KMG
tocreate a price elasticity of demand very near zero in thecoming years.
y
 
L
ikely rebound from unusually low inventory levels will positively impact
KMG
.
y
 
D
ebt to equity ratios have increased substantially from2009 to 2010 due to the acquisition of 
G
eneralChemical
s electronics division.
D
ebt to equity is highfor the industry and could restrict immediate acquisitionopportunities, weaken access to credit, and negativelyimpact investor confidence.
y
 
Concrete or plastic substitutes could negatively impactthe wood treatment product segment.
y
 
U
nrealized synergies could weaken expected gains fromthe most recent acquisition.
Value or 
G
rowth: VA
LUE
 FY end: July 31stIndustry: Chemicals Number of Analysts: 3
S
HARES AND
ELATED
D
ATA
:
Current Price (9/22/10) $13.8152 Week High $21.8052 Week 
L
ow $10.61Avg.
D
aily Vol. 61,000
D
ividend Yield 0.58%Beta 1.3
M
kt. Cap. $155.1
MM
 Share Out. 11.23
MM
 Short Interest as % of Float 3.85%
O
WNERSHIP
:
Institutional Ownership 70%Inside Ownership 30%
 
Insider 
T
ransactions (
TT
M
) -1
MM
sh.
P
RICE
ATIOS
:
Price/
E
arnings (
TT
M
) 9.27Price/
E
arnings
G
rowth 0.7
I
NCOME
D
ATA
:
 Revenue (
TT
M
) $194.6
MM
 Revenue
G
rowth (5-year avg.) 34%
P
ROFITABILITY AND
M
ETRICS
:
 Operating
M
argin (
TT
M
) 15.5%RO
E
(
TT
M
) 23.0%
D
ebt/
E
quity 75%
T
OP
N
EWS
:
 KMG Chemicals Completes Acquisition of  Electronic Chemicals Business
Business Wire, 8:30 A
M
, 30
M
arch 2010
 KMG Chemicals Signs Exclusive Distribution Agreement with SolvayChemicals, Inc. for Farm Hygiene Product 
Business Wire, 4:01 P
M
, 14 June 2010
William and MaryM A S O NSchool of Business
Frank Batten Investment Fund
KMG Chemicals, IncOctober 04, 2010Paul Jacob, AnalystTicker: KMGBCurrent Price (9/22/10): $13.81Target Price: $20.00Exchange: NASDAQRecommendation: BUYETF: IYM
I
NVESTMENT
H
IGHLIGHTS
 B
ASIC
I
NFORMATION
:
 
[2]
 
KMG
Chemicals, Inc. is a stock that has noticeable opportunity for price gains going forward.
T
his belief is based on both empirical and qualitative evidence.
E
MPIRICAL
:
E
mpirically, two valuations show that
KMG
stock is attractively priced.1.
D
CF:A
D
CF model with conservative inputs produced a price of approximately $20 per share, slightly lessthan the $22 that analysts predict.
T
he sensitivity analysis from this model shows that valuationsensitivity to a 1% change in margin is approximately 2.5x as large as sensitivity to a 1% change inrevenue growth, indicating that the ability of the company to increase margins is vastly more importantthan its ability to grow revenue.
L
ooking at recent margins, it is clear that
KMG
has done an effective jobincreasing margins to a level consistent with other major players in the chemicals industry. Some of thisis due to the more complete integration of previously acquired businesses, some is related to increasedthroughput from expanded market presence, and the rest is operational efficiency that comes fromreduced working days (the company currently operates on a 4 ± 10 hour day shift) and other overheadminimization efforts. Furthermore, the argument could be made that given
KMG
s large presence in a fewsmall markets, low price elasticity in the future will allow for greater marginal growth.2. Relative Valuation:
T
he relative valuation showed that
KMG
has a lower P/
E
, P
E
G
, and
E
V/
E
BI
TD
A than most of its peersand is therefore attractively priced. Based on this analysis,
KMG
is relatively priced at around $22 per share, in line with analyst expectations. While relative valuation didn't produce a directly comparablesized company, it did show that
KMG
is attractive at its current and past RO
E
. For instance, since theinception of its acquisition program,
KMG
has grown diluted earnings per share by 20% CA
G
R (2002 to2009). Based on both analyst expectations and industry analysis (as discussed in the qualitative section), itis clear that
KMG
will continue to outperform its peers on equity return, making it an attractive positionfor this industry.
Q
UALITATIVE
:
T
he largest argument for the Buy recommendation on
KMG
is qualitative.
T
he following positiveobservations are expected to generate earnings surprises in the future:
y
 
Having three business segments allows
KMG
to diversify some of the macro-risk that exists for other small companies.
y
 
T
he semiconductor market is expected to rebound after a couple negative growth years.
G
iventhat the electronics segment is the largest of 
KMG
s three segments, the predicted +7.8% CA
G
for the industry going forward will likely translate directly to
KMG
s bottom line.
y
 
T
he recent acquisition of 
G
eneral Chemical's
E
lectronics division will offer noticeableopportunity for expanded market share due to the fact that there was only a 20% overlap incustomers between the two companies, but an 80% overlap in products lines.
y
 
It is expected that
KMG
s expanded presence in Asia which resulted from the acquisition, presentsnotable market opportunities since Asia is the largest geographic market for the high-purity wet- process chemicals used to clean semiconductors.
y
 
KMG
has a proven history of acquiring, integrating, and operating businesses in the specializedchemical industry. With this most recent acquisition,
KMG
has proven again that they are able tofind opportune businesses at attractive prices (less than 4x
E
BI
TD
A).
 
INVESTMENT
 
THESIS
 
[3]
 
y
 
It is expected that
KMG
's product will attract greater demand in the last fiscal quarter due toinventory restocking after unusually low inventory levels in most of its primary markets.
y
 
When the economy recovers, demand for 
KMG
products is likely to surge for two reasons. First,in the wood treatment market, companies have neglected maintenance since the recession beganas a means to control costs.
G
oing forward, it is expected that when maintenance recovers,demand will surge from a backlog of neglected needs. Second, in the animal health andelectronics businesses, the products are more dependent on discretionary spending. If theeconomy recovers, discretionary spending will likely ramp up as consumer confidence increases.
y
 
T
he meat market is expected to stabilize after four years of negative growth, increasing the valueof 
KMG
s animal health segment.
I
NVESTMENT
ISKS
:
y
 
E
conomic instability leading to a double dip recession would negatively impact
KMG
stock.
y
 
D
ebt to equity ratios have increased substantially from 2009 to 2010 due to the acquisition of 
G
eneral Chemical
s electronics division.
D
ebt to equity is high for the industry and could restrictimmediate acquisition opportunities, weaken access to credit, and negatively impact investor confidence.
y
 
Concrete or plastic substitutes could negatively impact the wood treatment product segment.
y
 
U
nrealized synergies could weaken expected gains from the most recent acquisition.

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