AZZ Incorporated Feels the Heat From Oil and Gas

By Markets

The oil and gas industry claimed its latest victim when galvanizing and electrical products company AZZ Incorporated (NYSE: AZZ) disappointed the market with its second-quarter results. Let's take a closer look at what went on in the quarter.

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AZZ Incorporated's second quarter: The raw numbers

The headline figures:

  • Second-quarter revenue of $195 million represents a 9% decline from $214.2 million last year.
  • Operating income declined 44% to $14.9 million from $26.4 million last year.
  • Incoming orders in the quarter were $193.7, million resulting in a book-to-bill ratio of 0.99, compared with 1.09 in last year's second quarter.

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Even given that the second quarter tends to be a seasonally weaker one for AZZ, and that the company's earnings also tend to be lumpy, it was still a disappointing result that caused management to lower full-year guidance:

  • Full-year fiscal 2017 revenue is expected to be "slightly below" the previous guidance range of $930 million to $970 million.
  • Full-year fiscal 2017 EPS, excluding impact of the divestiture of the nuclear logistics business, is also expected to be "slightly below" the previous guidance range of $3.15 to $3.45.

CEO Tom Ferguson explained why management wouldn't give an updated specific guidance range: "Given the uncertainties noted above and the potential charges related to the sale of Nuclear Logistics LLC, we will suspend our guidance for a short window until we have more clarity on these issues and the effect on EPS and sales."

What happened in AZZ Incorporated's second quarter?

The company reports out of two segments -- galvanizing, and an energy segment that makes electrical products -- and both were hit by weaker capital spending conditions in the oil and gas industry. It's doubly disappointing because management was expecting growth and margin expansion in both segments in 2017.

Segment Revenue (Millions) Growth Operating Income (Millions) Growth Margin Change (Basis Points)
Energy $97.6 (11.9%) $8.2 (9%) 8.4% 30


$97.4 (5.8%) $15 (41%) 15.4% (910)
Total $195 (9%) $14.9 (43.6%) 7.6% (470)


Galvanizing segment

The dramatic decline for the galvanizing segment occurred because the company "made the strategic decision to reduce capacity in the Southern U.S. by closing production at two of our galvanizing plants" while "repurposing" a third plant. The result was a realignment charge of $7.3 million.

If you add this back to the operating-income figure, it results in a galvanizing operating income margin of 22.9% -- not bad, but still a far cry from the 25% margin management is targeting.

Earlier in the year, management had discussed some pricing pressure in the galvanizing segment, and its exposure to oil and gas spending in the Gulf Coast is well known -- West Texas and Oklahoma were particularly hard hit. These pressures came home to roost in the second quarter, and management was forced to take action that hit its earnings and full-year outlook.

Energy segment

Turning to the energy segment, Ferguson outlined how "we have also taken steps to reduce management costs in our specialty welding business, which is feeling the effects of reduced turnarounds in domestic refineries." Consequently, the energy segment took a realignment charge of $0.7 million, which held back margin expansion in the quarter.

Looking ahead

The next step for investors will be to look out for the updated guidance and hope for a long-awaited pick-up in capital spending in the oil and gas industry. As management explained on the earnings call, galvanizing is a business that doesn't operate with long lead times, so any kind of downturn (or upturn) will be felt quickly in AZZ revenues.

The impact was negative in the current quarter, and investors will be hoping for a more positive surprise in future. All told, the weakness in energy spending hit home in AZZ's quarter, but it may not prove to be a lasting issue.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Azz. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.