Technical Ability Keeps Oil Additive Maker At The Top Of The Heap

• Brad Kelly
• On 5:54 pm EDT, Thursday October 29, 2009

Some say innovation is the ability to see change as an opportunity, not a threat.

In 81 years of business, Lubrizol (NYSE:LZ - News) is widely regarded as the most innovative additives company around. And it has never backed down from a challenge.

Lubrizol develops oil additives designed to protect all types of engines in the global transportation, industrial and consumer markets. It also makes specialty chemicals used in the personal care, industrial, medical and construction sectors.

The Wickliffe, Ohio-based company's unique understanding of chemistry, technology and the engine oil market has created a product suite that has kept pace with engine evolution over the years.

In the 1930s, its first big seller, Lubri-Zol, fulfilled the demand for motor lubricant as automobile manufacturing ramped up by the millions. When opportunity knocked, Lubrizol answered.

It supported the war effort in the 1940s by producing more than half of all the engine oil additives for automatic transmissions used by the military. During this time, Lubrizol developed many cutting-edge lubricants that allowed engines to work under extreme pressure.

Reacting To Circumstance

The company kept introducing new products. In 1974, amid the gas crisis, the company made additives that improved fuel economy. The 1980s were a watershed decade of technology firsts for Lubrizol.

The company's products are the result of the ongoing maintenance needs of the roughly 700 million global car, truck and bus vehicles, says JPMorgan analyst Jeffrey Zekauskas. New emissions legislation for the auto industry will drive Lubrizol's innovative spirit and growth in the future, he says.

"Its set to capture long-term market expansion prospects that stem from stiffer pollution control requirements that lead to complex engine designs and new lubricant formulas," he said. "More fuel-efficient engines, operating at higher temperatures, can also lead to increased use of performance additives in motor oil."

Backed by decades of experience in the science of lubrication additives, Lubrizol's technologies meet the needs of today's engines: increased durability, reduced emissions and improved fuel economy.

Innovation has helped Lubrizol keep prices stable, even with a recession, because customers can see the payoff. But pricing pressures are starting to come from competition among additive suppliers as they chase limited volume, says Dmitry Silversteyn, an analyst at Longbow Research.

During the recession, Americans changed their travel habits, bought more fuel-efficient cars and switched to public transportation, leading to a decline in motor oil use. The trend toward smaller cars and less miles driven translates to fewer oil changes and a reduction in oil volume per change, Silversteyn says.

NewMarket (NYSE:NEU - News), Lubrizol's top rival, posted a 26% drop in volumes in the first quarter this year and announced price adjustments during the quarter. Several smaller industry players have cut prices to sustain volumes.

"Lubrizol has kept prices unchanged at this time," Silversteyn said. "But given that the top four players have over 90% market share of the lube additives and at least one player is already reducing prices, others may follow suit."

Second-quarter volume in Lubrizol additives and advance materials fell 18% and 29%, respectively. The levels dropped again in the third quarter, which it reported Wednesday.

Lower volumes and a weak dollar have sparked four straight quarterly sales declines, falling 6% to $1.27 billion last quarter. Analysts expected revenue of $1.18 billion.

But overall sales and volume increased sequentially as customer destocking appeared to be over. Another bright spot was Lubrizol's higher margins, thanks to lower raw material costs.

The price of base oil, the main ingredient in additives, fell to $2.80 a gallon in July vs. $5 a gallon during the same time last year, according to Longbow Research. Margins were also boosted by positive pricing and cost-cutting initiatives.

The company's cost of sales fell 24.5% during the quarter to $814 million, boosting overall margins to 36%. As a result, profit more than doubled to $2.52 a share, ex items, matching analysts' estimates.

"I believe our performance is sustainable and that earnings will benefit from both broader economic recovery as well as from our organic growth initiatives of product innovation and geographic expansion," CEO James Hambrick said in a statement.

Despite uncertainty over global economic growth and head winds from price pressures and currency exchange rates, Lubrizol raised its full-year profit outlook for the second time this year.

Lubrizol now expects 2009 profit of $6.82 to $7.02 a share ex items, vs. a prior view of $6.10 to $6.40. It cited improving volume trends and cost reduction measures.

"Should Lubrizol prove successful in maintaining product prices and should demand rebound faster than we expect, near-term earnings may exceed our forecast and the share price may appreciate accordingly," Zekauskas said.

Acquisitions have been a big part of Lubrizol's growth over the years. It bought metal coatings maker International Rustproof in 1957, kicking off a half-century of strategic purchases. It expanded its presence in the specialty chemical market in 1996, by acquiring CPI Engineering Services.

Building on the success of eight smaller buys since 2000, Lubrizol stepped up its diversification by acquiring Noveon International in 2004 for $1.84 billion.

The deal doubled the size of Lubrizol into a $3.2 billion global company. At the time, sales were evenly split. But its additives business has grown, accounting for 71% of the $5.03 billion in 2008 sales.

Latest Acquisition

Most recently, it acquired the thermoplastic polyurethane unit from Dow Chemical (NYSE:DOW - News), expanding its engineered polymers business. The deal closed Dec. 31, 2008.

Noveon continued the company's innovative tradition by discovering new chemicals with unusual properties that solved problems and developed new products.

For instance, when personal care makers needed a way to include beads in facial washes without having them sink to the bottom, Lubrizol made a compound that was both clear and stable on store shelves.

Lubrizol will continue to hunt for bolt-on acquisitions that will fill holes or enhance its portfolio, because it has the cash to do so, Silversteyn says.

In the first half of 2009, cash flow from operations was $447 million, up from $99 million in 2008 as Lubrizol kept capital spending under control due to the uncertain environment.

It shelled out just $76 million over that span, leaving plenty in the company coffers.

Buzz up!