Azz Inc. Reports Another Weak Quarter

By Lee Samaha Markets Fool.com

The market has been merrily pricing in a recovery in industrial market conditions, most notably in oil and gas-related spending, but the latest results from galvanizing and specialty electrical equipment company Azz Inc (NYSE: Azz) suggest the recovery may take longer than some might have expected. Let's look at the earnings and management's commentary.

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Image source: Azz Inc.

Azz Inc. third-quarter results

Azz has two operating segments -- galvanizing and an energy segment that makes electrical products -- and both saw revenue declines in the third quarter. In fact, the only positive change in the metrics we'll look at in a moment was a slight increase in galvanizing margin, although even that was below previously announced expectations.

The usual suspects turned up in the third quarter, with CEO Tom Ferguson beginning the earnings call by saying, "Results in Q3 were quite disappointing as we faced continued contraction in our markets due to the economic fallout of low oil patch activity, lower solar opportunities, and a low level of major refinery turnarounds."

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It's doubly disappointing because management was expecting revenue growth and margin expansion in both segments in fiscal 2017. For reference, back on the fourth-quarter 2016 earnings call in April, Ferguson had called for galvanizing margins "north of 25% as we get to the end of the year" and mentioned that, in time, energy margin could go to above 15%. Both segments are some way short of these targets right now:

Segment

Sales

Increase

Operating Income

Increase

Margin

Increase (bp)

Energy

$135.6 million

(0.3%)

$15.4 million

(18.1%)

11.4%

(250)

Galvanizing

$91.9 million

(13.7%)

$21.3 million

(12%)

23.2%

40

Total

$227.5 million

(6.2%)

$28.8 million

(20.9%)

12.7%

(237)

Data source: Azz Inc. presentations; bp = basis points,where 100 bp equals 1%.

Galvanizing segment

The segment's galvanizing operations continue to be hit by weak oil and gas-related spending, most notably showing up in Azz's facilities in south and west Texas, Oklahoma, Louisiana, and the Gulf Coast -- and Ferguson spoke of seeing problems spreading "a little bit" to other parts of the industrial economy. In reality, it's a continuation of the conditions seen in the second quarter, and it seems to have surprised Ferguson, who said,"we thought we were seeing some improvement as we entered Q3 from our core markets, but this did not transpire."

Clearly, it's going to take longer than previously expected for an upturn in the segment, and pricing pressure could continue. After analysts asked when the increases in rig counts and manufacturing surveys would start to be felt in segment sales, Ferguson said "it's normally an eight-to-12-month cycle before you see that" -- hence his forecast that conditions would get better in the latter half of Azz's fiscal 2018.

Energy segment

The margin decline was put down to a relative shift in sales from higher-margin products toward lower-margin ones. However, Ferguson took a notably more bullish tone on the segment's immediate prospects.

The segment reported weakness in tubing and lighting for the oil industry, and WSI -- a maintenance, repair, and overhaul business serving nuclear and industrial customers -- saw project deferrals on major refinery work. It's work that is likely to get done at some point, and Ferguson expressed confidence that conditions would get better in the spring.

In addition, he claimed the electrical businesses within the energy segment had a "very good bookings quarter," leaving the company with a solid backlog for fiscal 2018.

Looking ahead

All told, it was another disappointing quarter, but management argued that conditions would get better in its fiscal 2018. Within galvanizing, Azz investors should look out for an improvement in oil and gas-related spending and some pickup from any potential infrastructural spending as a consequence of Donald Trump's victory. Meanwhile, the energy segment needs to see the anticipated project work in refining kick in during the spring.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Azz. The Motley Fool has a disclosure policy.