As we approach 2022, I would say that one of the biggest questions for HB Fuller (FUL) (“Fuller”) is whether the company can maintain the robust pricing it achieved in the second half and deliver good volumes against what will be more challenging comps for the first three quarters of 2022.
I thought HB Fuller was both undervalued and well leveraged to improve end markets a year ago, but I didn’t expect the strength the company has shown in 2021, and stocks are around 25% higher now. This performance was way above this rival Henkel (OTCPK:HENKY) managed, but not as strong as Arkema (OTCPK:ARKAY), and more or less in line with the much-loved Sika (OTCPK: SXYAY).
At this point, I still have my doubts about Fuller – the company’s long-term margin performance hasn’t been as strong, and I doubt the company can truly differentiate its products in the marketplace. If they can hold the price line, that’s a strong argument in their favor. I still view Fuller as potentially undervalued if it can generate improved margins (in addition to long-term revenue growth of around 5%), but that’s not a small “if” for the business.
Robust prices offset lower volumes, but results were lumpy
Fuller’s fourth quarter was mixed. Earnings reports were pretty good, especially in a quarter where many specialty chemicals companies disappointed, and guidance was pretty strong as well. On the other hand, a company has done the heavy lifting and the assumptions that go into management guidance are not necessarily conservative.
Revenue increased 15% in the quarter, with volumes contributing just over 1% to organic growth and the remainder coming from prices (up over 13.5%). The Engineering Adhesives (or EA) and Hygiene, Health, and Consumable Adhesives (or HHC) businesses grew 13% driven almost solely by price, while Construction grew 29% driven by both price strong results and double-digit volume growth.
Not only was Fuller able to weather steep price increases in the second half of the year, but the company also faced much lower input cost pressure than many other specialty chemical companies – from l 15% to 20% overall versus 20% to 35%. So, in a quarter where many companies came under significant pressure on margins, Fuller’s adjusted gross margin was close to flat versus the prior year period at 27.1% (down 40 points). basic).
EBITDA was up 9%, beating around 1%, with margin down around one point to 14.9%. It was all building, with 70% growth in this segment, a 43% beat from the street, and a tripling of margin to just over 9%. EA’s EBITDA rose 4%, missing 5%, with margin down 140 bps to 16.8%, while HHC’s EBITDA rose 1%, missing nearly 4% , with a margin down 140 bps to 10.7%.
Can Fuller reap more volume growth and hold its prices?
Looking to 2022, I think there is reason to remain bullish on Fuller’s underlying markets.
The automotive sector accounts for over 10% of the adhesives industry, and after well-publicized volume issues in 2021 due to supply shortages (mainly chips), there should be some improvement in 2022. , as OEMs release more hybrids and electrics, this share is expected to increase as efforts to reduce the weight of new vehicles typically include replacing mechanical fasteners with adhesives.
I also think packaging should stay healthy for Fuller as increased interest in “sustainable” packaging drives changes in the product line. I think demand for hygiene should be stable, with companies likely looking to replenish inventory after production issues in late 2021 and early 2022 due to the pandemic and supply chain disruptions. I also expect construction to be healthy as residential activity remains strong and commercial activity improves.
Other than maybe electronics, where I might see some slowdown in consumer electronics and where Fuller isn’t a big player, I don’t see too many weak spots. With that, as long as underlying economic growth remains healthy, I think low single-digit volume growth should be achievable (helped by stronger construction growth).
Where I have the most doubts is on the price side. Management believes it can and will make pricing surcharges permanent, but pricing strength has not been typical for Fuller. Maybe the company didn’t realize the leverage it once had on pricing; As I said before, the lack of pricing leverage has been one of my concerns with the company as pricing can reflect position in the market. 3M (MMM), for example, has long enjoyed high prices thanks to the strength of its innovation-driven market share.
On the other hand, and going just beyond the specifics of Fuller and the adhesives segment, many forecasters claim that the price spikes we have seen will not be sustainable and that prices will fall as market bottlenecks continue. ‘supply squeeze will dislodge. As a close friend of mine (who works as an economist) likes to say, the hall of fame for inflation/interest rate forecasters is empty for a reason, so there may not be the expected price correction. Either way, it’s absolutely something to watch here, and if Fuller can keep those prices higher, I think it will have significant ramifications not just for margins (assuming the cost pressures of inputs eventually fade), but also for the perception of the company’s position on the market.
I can’t fault the company for how it handled the challenges of the past two years, but I still have concerns about the company’s position in the market and its ability to improve on what has always been poor margins (compared to industry peers).
I have upgraded my revenue expectations, including low double-digit revenue growth in 2022 and longer-term mid-single-digit growth, in line with past performance. While I believe underlying volume growth in areas such as “general industrial” and consumer hygiene will likely be in the low single digits, and packaging will normalize to At some point, I see growth opportunities in areas like automotive (lightweight electric vehicles) and energy (solar panel) that could help sustain this mid-single-digit growth rate.
I am still reluctant to increase my margin forecast, especially given my concerns about the sustainability of management’s pricing actions. Also, I expect FCF margins to improve sustainably in the high numbers from a historical average around the mid numbers, so I don’t think I’m being that conservative.
All told, I’m looking for long-term mid-single-digit revenue growth and mid-to-high single-digit FCF growth, with an adjusted EBITDA margin still lagging pre-pandemic levels through 2023 at least, if not until 2024. Between discounted cash flow and a margin/return driven EV/EBITDA model (with a forward multiple of 11.5x), I think these stocks could still have an edge towards $80.
Even so, it’s still not a preferred name. At the risk of harping, I’m still not convinced of the company’s position and strategy in the market, or its ability to maintain its prices. With these doubts, I don’t see enough upside to want to take the risk with my own money.