Koppers Holdings Inc., a company specializing in treated wood products and carbon compounds, surprised analysts during their Q1 2024 earnings call. While the focus was expected to be on the dip in adjusted EBITDA and the acquisition of Brown Wood Preserving Company, CEO Leroy Ball's comments hinted at a high-stakes game of chicken with a significant portion of their railroad customer base.

Ball expressed frustration with certain railroad companies' refusal to grant price increases to offset pandemic-driven cost surges. He stated, "Koppers will not compromise safety or product quality, but we've probably been going too far to satisfy what the industry says it values, and we need to shift our focus and priorities to producing a product that's in line with what certain customers behaviors say about what they really value, which is price."

This statement reveals a potential power play: Koppers may reduce services and operational flexibility beyond contractual obligations, betting that these railroads are more reliant on Koppers's service and quality than they admit.

Koppers has already achieved price adjustments with over half of its railroad customer base, demonstrating some companies' willingness to acknowledge the cost environment. However, a significant portion of their tie business remains locked in a pricing standoff.

Koppers' Strategy Shift

Ball's cost-cutting strategy targets inefficiencies arising from accommodating specific customer demands, such as excessive overtime and boltonizing, a less efficient treatment process often necessary due to inconsistent green tie procurement. Streamlining operations to strictly adhere to contract terms could yield substantial cost savings for Koppers.

The gamble hinges on whether this strategy will compel railroads to accept reduced service levels to maintain low prices or concede to Koppers's price increase demands to ensure the smooth operation of their essential infrastructure.

"Ball expressed confidence in Koppers' leverage, stating, "We continue to explore other uses for our treating assets, so that we can get back to earning our cost of capital on our investments if we can't figure out a way to make it work with certain rail customers," suggesting that Koppers has viable alternatives if these relationships sour."

The risks are significant: If railroads hold firm and Koppers fails to redeploy assets quickly, the company could suffer revenue and profitability losses. However, a successful resolution would not only improve Koppers' margins but also set a precedent for future negotiations, potentially reshaping industry dynamics.

Koppers' Financial Performance

While this high-stakes standoff could disrupt the U.S. rail system, it has largely gone unnoticed by financial analysts. Here's a closer look at Koppers' financial performance:

Segment Performance

Koppers operates in three segments: Railroad and Utility Products and Services (RUPS), Performance Chemicals (PC), and Carbon Materials and Chemicals (CMC).

RUPS

RUPS saw a 5.6% increase in sales year-over-year, but profitability was impacted by higher operating costs related to labor, raw materials, and SG&A expenses.

PC

PC showed strong sales and profitability growth, driven by volume increases, particularly for copper-based preservatives.

CMC

CMC experienced a decline in sales and profitability due to lower market demand and prices for carbon pitch, as well as a weather-related outage at their Stickney, Illinois plant.

EBITDA Trend

The following chart depicts Koppers' adjusted EBITDA trend over recent years. Note the significant decline in Q1 2024 compared to the previous year.

Koppers' Outlook

Koppers maintained its consolidated sales growth guidance of 4% to 5% for 2024. However, they adjusted their adjusted EBITDA target to a range of $265 million to $280 million, reflecting the challenges faced in the CMC segment and uncertainties surrounding the timing of benefits from the Brown Wood acquisition.

The company is pursuing several initiatives for long-term improvement in CMC, but most are expected to materialize in 2025. Koppers remains optimistic about achieving its 2025 adjusted EBITDA goal of $315 million to $325 million, which includes contributions from Brown Wood.

"Fun Fact: The average wooden railroad tie lasts about 7 to 10 years in service. Koppers' focus on high-quality, treated wood products aims to ensure the longevity and safety of America's rail infrastructure."