Why the Selloff in H.B. Fuller Is Overdone

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H.B. Fuller Co. (NYSE:FUL) isn’t a household name, but Wall Street knows this company. Its stock is up 60 percent in two years, and the company has been growing. However, its most recent quarter was disappointing, and the stock is on sale now. In this article, I will discuss the company, its quarter, and why I think it is time to get long on this overdone selloff. So, how is H.B. Fuller? Well, this company formulates, manufactures, and markets adhesives, sealants, and other specialty chemical products.

It operates in four segments: Americas Adhesives; Construction Products; Europe, India, Middle East, and Africa; and the Asia Pacific segment. The company produces and supplies a range of specialty adhesives, such as thermoplastic, thermoset, reactive, water-based, and solvent-based products. It also offers caulks and sealants for the consumer market and professional trade.

The company provides its industrial adhesives products for applications in the assembly, packaging, converting, non-woven and hygiene, performance wood, flooring, textile, flexible packaging, graphic arts, envelope, and electronics markets. In addition, it offers construction products comprising adhesives, grouts, mortars, sealers, levelers, etc., that are used for tile setting, as well as duct sealants, weather barriers, fungicidal coatings, block fillers, etc., for heating, ventilation, air conditioning, and insulation applications. It is also working extensively to overhaul its internal processes.

The company has embarked on Project ONE. This is a multiyear project to install SAP application software as its global information technology platform. Its North American adhesives business went live on SAP on April 7. As expected, the initial go-live for the project disrupted its business processes and required a high level of technical support to stabilize. The duration of the disruption and, therefore, the cost of the technical support required, was significantly higher than anticipated, and this is what really hit the quarter. But it was investment.

Currently, the business processes and systems are stable and supporting the normal ongoing requirements of the business. The whole ordeal cost $8.1 million of unplanned and non-recurring costs. These costs include higher-than-expected costs of technical support for the initial go-live event as well as unplanned costs within the Americas adhesives operating segment to manage the business process disruptions following the go-live. That said, how was the quarter?

Well, net income for the quarter was $20.5 million, or 40 cents per diluted share, versus net income of $25.9 million, or 51 cents per diluted share, in last year’s second quarter. Adjusted diluted earnings per share were 78 cents, up 16 percent versus the prior year’s adjusted result of 67 cents. Net revenue for quarter was $544 million, up 4.8 percent versus the second quarter of 2013.

Higher volume and positive foreign currency translation positively impacted net revenue growth by 4.8 and 0.3 percentage points, respectively. Lower average selling prices negatively impacted net revenue growth by 0.3 percentage points. Organic revenue grew by 4.5 percent year over year. What really hurt was the change in gross profit margin.

Gross profit margin was down approximately 200 basis points versus the prior year’s result due to a variety of factors including excess costs associated with the business integration project in Europe and Project ONE, a temporary spike in the cost of certain raw materials in Europe, margin compression on certain products in its construction products business, and adverse foreign currency exchange effects in Australia.

The company’s expenses were up only about 3 percent, or $2.6 million, versus the prior year’s second quarter, despite absorbing unplanned and non-recurring costs related to Project ONE in North America. So that was a huge plus. Overall it was a weak quarter, but this is really attributable to Project ONE. I think it’s an opportunity.

So just what do we do here? I think you can buy this growth stock. It is trading about 23 times earnings but is making investments needed for growth. This is reflected in the balance sheet. At the end of the second quarter of 2014, it had cash totaling $95 million and total debt of $566 million. This compares to first-quarter 2014 levels of $113 million and $534 million, respectively.

Sequentially, net debt was up by $50 million. Its receivable balances were relatively high at the end of the quarter because sales in the final month of the quarter were strong and, to a lesser extent, due to the disruption of its normal billing processes during the Project ONE go live in North America. Capital expenditures were $31 million in the second quarter, with the bulk of this spending related to the company’s ongoing business integration activities and to support Project ONE.

Now that this is out of the way and economic activity is improving in most parts of the world, I think H.B. Fuller is in a good position going forward. Normally, after a quarter like this I would recommend holding the stock, but I think the selloff is overdone.

Disclosure: Christopher F. Davis holds no position in H.B. Fuller Co. and has no plans to initiate a position in the next 72 hours. He has a buy rating on the stock and a $52 price target. 

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