Cabot: Reinforcement Materials Strength To Continue To Drive Earnings Forward (NYSE:CBT)

Intro

We wrote about Cabot Corporation (NYSE:CBT) in January of this year when we upgraded our rating in the stock to a ‘Buy’ when shares were trading at approximately $74 a share. Since our upgrade, shares have returned approximately 38%, an excellent return over the past four months. Therefore, after divulging the company’s second-quarter earnings report (announced on the 7th of May this year), we are standing pat on our ‘Buy’ recommendation as momentum is certainly with the stock as we learn below.

Shares rallied violently out of their early February lows, and the recent gap this month (Due to the encouraging Q2 earnings report) on the daily chart appears to be a measuring gap. This type of gap makes itself known when the stock in question has been moving up aggressively on moderate volume, where the gap takes place around the mid-point of the underlying trend. This measuring gap should now act as support for shares of Cabot for the remainder of this trending move. However, in the unlikely event that an exhaustion gap has been printed, a trailing stop at roughly the $96 to $96.5 level is a sound strategy for protecting unrealized profits in this latest trending move in Cabot.

Although quite a few of Cabot’s trailing valuation multiples may now be coming in well above their historic counterparts, the mistake here would be to take profits too prematurely. Suffice it to say, if investors continue to buy the stock in spades, this means the company’s fundamentals remain bullish, all things remaining equal. To this point, here were some of the key trends we unearthed from the recent Q2 earnings report, which give credence to the momentum evident in Cabot’s technicals.

Guidance Gets Hiked Post Bullish Q2 Trends

Management increased full-year adjusted EPS to approximately $6.75 on the back of a very impressive Q2 bottom-line beat (EPS of $1.78 recorded). Earnings over a comparable basis increased by $0.45 per share due to strong growth in both the Performance Chemicals (EBIT growth of 11%) & Reinforcement Materials (EBIT growth of 22%) businesses. Suffice it to say, given current trends, it is not surprising to see any slowdown in consensus revisions, as we see below.

Cash-Flow Continuing To Drive The Financials

We have always reiterated that as long as a company can generate enough sales & corresponding cash flow, then this very same cash flow can be used to reward shareholders as well as make the company stronger over time. With over $170 million of operating cash flow generated in Q2, this is exactly what is playing itself out here from several standpoints. For one, with the dividend remaining well covered on a cash-flow basis, management decided to raise the payout by 8% earlier this month. In our last commentary, we went through the key metrics & trends that make up the dividend and found the payout to be on a very sound footing.

Furthermore, $24 million of cash was used to buy back stock in the quarter, which is easily affordable given $133 million of free cash flow was generated in Q2. In fact, given that $407 million of free cash flow has been generated over the past four quarters, we can state that Cabot’s trailing free cash flow multiple comes in just under 14. The ratio lets us know how much each dollar of free cash flow costs Cabot to generate. Therefore, the lower the multiple, the more free cash flow can be generated, which in turn should lead to sustained shareholder returns over time and rising book value.

Value Continuing To Be Added, Resulting In More Growth

Cabot’s forward-looking fundamentals in both the ‘Reinforcement Materials’ segment as well as ‘Performance Chemicals’ continue to be bullish. However, it is the much larger ‘Reinforcement Materials’ segment where we see the stronger fundamentals, buoyed by strong double-digit growth rates. Volumes increased globally by 6% in Q2, with favorable pricing remaining to the fore. Higher volumes are expected in the Americas going forward and in Q3.

Furthermore, due to how climate change has forced manufacturers of tire-related components to come up with solutions, Cabot continues to add value in this space through updated solutions. This is demonstrated initially by the recent award won by the E2C product line concerning improved tire performance. Here we see how Cabot continues to advance its technology in the tire market, as described by the CEO on the company’s recent Q2 earnings call.

Our E2C DX9660 elastomer composite, produced through a proprietary and patented mixing process, enhances tire performance by increasing abrasion resistance by approximately 30% without compromising rolling resistance when compared to conventional rubber compounds. This E2C platform has been validated by global customers and our products are being sold in the tire market. Additionally, our E2C platform offers an array of products tailored to meet the needs of tire manufacturers and industrial rubber applications, combining performance with sustainability benefits.

Furthermore, the recent launch of the PROPEL E8 offering is also expected to be a winner, considering the imminent need for tires to last longer under the weight of the heavier electric vehicle. Due to the large battery pack in electric vehicles, these cars can come in up to two times the weight of a petrol alternative. This ‘extra’ weight can certainly take its toll on tires and their shelf-life, but the PROPEL E8 promotes both improved efficiency & durability through lower rolling resistance for tires used with electric vehicles.

Conclusion

Therefore, to sum up, despite strong gains in the past months, we are maintaining our ‘Buy’ rating in Cabot Corporation. Encouraging technicals coupled with strong cash-flow trends and bullish fundamentals in the Reinforcement Materials segment in particular led to a guidance hike on the recent Q2 earnings call. Risk should be managed through the technicals by specifically monitoring if the recent upside gap remains unfilled going forward. We look forward to continued coverage.