Get on the road with this manufacturer of specialty industrial materials. Lydall’s July 8 purchase of Texel diversifies its business into highly profitable ‘geosynthetic’ products used for roadway engineering and flood management. Although demand has been strong for the auto components that Lydall sells, this acquisition will lower the risk of reduced profits when auto manufacturing hits a speed bump.

Lydall is on a roll. Large gains in the profitability of Lydall’s auto products and cuts to its lower-margin life science products business lifted earnings 20% in 2015 despite a 2% decline in revenue. The Texel business sports a margin higher than most of Lydall’s products and puts Lydall closer to its 2018 goal of $800 million in revenue, up from $523 million last year, and a 50% increase in profit margins.

Buying Texel lets Lydall leverage its manufacturing expertise in specialty non-woven materials. Lydall can increase the use of its own factories, add on proprietary processes discovered by Texel and then sell to customers in adjacent industries. This acquisition promises to usher in another 20% profit gain in 2016 and beyond. Target $62.

Like most of our Profit Catalyst names, Lydall came to our attention when it traded six times its average volume of shares on July 11 (see chart at left), the day after the company announced its purchase of Texel. This volume spike is usually a good indicator that a catalyst is afoot at a company and future gains may be coming.

Geosynthetics

We’ll admit we engaged in some serious googling upon hearing the term geosynthetics. It turns out geosynthetics is a hopping industry right now. According to Transparency Market Research, demand for geosynthetics should grow 9% annually for the next 10 years.

Geosynthetics are materials used to stabilize terrain, improve drainage systems and create natural barriers. The extreme weather swirling around the globe shows little sign of stopping and creates huge demand for geosynthetic materials, as municipalities rebuild structures and roadways washed out by floods or flattened by wildfires.

In addition to geosynthetics, Texel sells specialty industrial and medical materials and filters. Lydall is champing at the bit to sell its own portfolio of products to these new customers.

Says Lydall CEO Dale Barnhart: “Why are we so excited about this acquisition? It gives us the ability to take a very similar manufacturing process, where we can leverage best practices and take us into some growth markets: geosynthetics, liquid filtration and some medical applications.”

Auto Business Humming

The company’s auto business is strong, but management often repeats its goal of reducing auto revenue to less than 50% by 2018. Total revenue for parts supplied to auto manufacturers grew 2% in 2015 and made up 57% of revenue. While it is admirable and wise that Lydall diversify away from the cyclical auto business, stable growth from this sector pushed profits up in 2015.

Revenue for acoustic fibers, Lydall’s most profitable product line, grew 12% in 2014 and 8% in 2015. These specialty materials reduce the weight and vibration of autos. Environmental Protection Agency rules calling for a 65% reduction in emissions and a 53% improvement in fuel economy by 2025 are prodding automakers to search for new ways to reduce the weight of cars and leading them to Lydall’s doorstep.

Acquisitions Pending

Lydall management notes it plans to lower the mix of automotive sales iby investing in filtration and engineered-materials businesses.

Lydall has already proven itself adept at capitalizing on acquisitions after successfully integrating its 2014 purchase of Andrew Industries Ltd. That purchase, which also added new products in adjacent industries to Lydall’s offerings, included a new product line that grew 10% to $139 million in revenue in 2015. Since then, Lydall has almost doubled profit margins for the Andrew’s product line.

Lydall has plenty of flexibility on its balance sheet to finance more acquisitions. Total debt on March 31 was $10 million. An additional $85 million was borrowed to help pay for Texel’s $96 million purchase price, leaving Lydall with almost $100 million available in its credit facility. The company had already paid down 65% of the money borrowed to fund the Andrew Industries purchase from 2014.

Target: $62

Analysts have yet to adjust their 2016 and 2017 estimates for the Texel acquisition. We estimate it will boost earnings 21% in 2016 and then another 21%, to almost $3, in 2017. We will be reviewing this target as Lydall begins to show off the benefits of the Texel purchase. Tuck this specialty materials producer into your portfolio for improved performance.