Thesis: Celanese is a $15b chemicals company, with no pure peers, that is often ignored. People often think of Celanese as a commodity chemical and cigarette filter company; but, the real gem is its Engineered Materials business, which is a capital-light, fast growing, highly profitable enterprise that faces little competition. Yes, ce also makes commodity chemicals, but the backdrop is for continued tightening supply/demand in the upstream operations. Management has been great capital allocators and there is likely upside to their $11.00 2020 EPS Target, not including share repurchases. In fact, buybacks alone, improve their target to near $12.00. The stock trades for $115 at under 12x NTM EPS.
Celanese sells some of its plastics products into the merchant market, but also mixes them with other materials into highly specialized and customized compounds.
In 2015, Celanese introduced a project model that starts with a combination of its portfolio of plastic compounds and matches them against a specific customer need (such as autobody parts, medical devices, or electronics components). This is an interesting business model because each project has a size as small as $100,000 in revenue. Thus, each opportunity isn’t significant alone, but they have been able to leverage these relationships across different customers, geographies, and products. The result is that they have little competition in this approach and have been able to increase the number of “projects” to 5,000 from just 1,000 in 2015.
On the third quarter 2017 conference call, Celanese discussed an example: a hammer. The typical hammer has a wood or another composite. Celanese developed a material with nylon polymers and elastomers that improved the handle strength, resistance, and aesthetics. This technology saves manufacturers processing costs and time compared to wood. I know this doesn’t sound like much, but then CE can take this knowledge and apply it to other products. This may seem like a simple operation, but because these are smaller projects, CE claims it faces almost no competitive pressure.
If you are familiar with Flextronics (a tech manufacturing services company that assembles electronics for its customers), this business is similar to their sketch-to-scale where FLEX partners with vendors throughout the design process. It’s a higher-margin, less-capital-intensive approach.
CE is targeting 6-9% organic volume growth in the Engineered Materials segment over the next few years and for EBIT to grow from $600m in 2017 to $900m+ by 2020.
Historically, many folks rightfully associated CE with producing cigarette filters. However, in 2017, this business was just 25% of total operating profit, down from ~40% from 2009-2013. And, operating profit is expected to remain flat through 2020, resulting in an even lower percentage of EBIT in the future.
Earlier this year, CE had an arrangement with Blackstone to form a JV that was designed to monetize and exit the business and reallocate that capital to higher-growth ventures. That fell through, but the company is considering future options which could convert future value to cash available today.
Regardless of the future for this segment, it should continue to throw off cash until a solution is found.
Celanese is a leading producer of Acetic Acid, which is simply an upstream chemical that ultimately goes into polymers (plastics and resins). In this upstream segment, CE specifically makes money from the production of Acetic Acid and its derivatives, such as Vinyl Acetate Monomer (VAM). These are key inputs for many specialty/complex engineered products that are ubiquitous in today’s world. CE either sells its finished upstream product in the merchant market or further develops it for use in its Engineered Materials segment (discussed above).
Outside of China, which produces roughly 70% of global capacity, Celanese (17% of the market), BP (9%), and Eastman (6%), control most of the production.
History of Acetyls Chain – Historically, the Acetic Acid industry had been reasonably disciplined, until around 2010-2012, when the Chinese added about 20% to global capacity, crushing utilization, which then bottomed near 75-80% around 2012-2013. However, China has not added any capacity since 2014 and production in China may actually decline because of new environmental controls.
As evidence of CE’s low-cost position, even when utilization was that low, it earned ~$300m of operating profit in 2012-2013, which was about a 9% margin. In 2017, operating profit was $500m. Management has guided to $900m+ of EBIT by 2020, but if the market tightens as expected, it could surprise to the upside.
Supply / Demand
Demand has grown (and is expected to grow) low-single-digits year-over-year. Even in 2008/2009, the level of demand only dropped slightly.
Excluding any Chinese shutdowns, global operating capacity is expected to be flat over the next few years, allowing the utilization rate to increase to near 90% by 2020, from the low-80%-range today. Furthermore, it’s possible that China may reduce capacity (because of environmental regulations), which would result in a few additional points of utilization benefit by 2020.
It takes two-to-four years to bring on new capacity (maybe towards the lower-end of that range in China) and no new expansions have been announced.
Feedstock Advantage – The initial raw material for producing acetic acid is either natural gas, oil, or coal (which is mostly used in China). Most production sites cannot switch between feedstocks, but Celanese operates plants that use all three feedstocks. So, as the spread between feedstocks widens (and the price is set by the highest cost input), Celanese can capture the cost advantage of a lower-priced feedstock. For example, when oil prices were low in 2016, Celanese operated its oil-based unit in Singapore at similar levels to its gas-based units. In 2012-2014, that oil-based unit operated at low rates given the high oil costs. It’s difficult to know exactly how much flexibility Celanese has with its plants, but this capability does support the fact that their margins were healthy when utilization levels were at their lowest point.
Plus, the increased price of coal weakens the economics for China-based capacity and lowers the likelihood of additional capacity (even if environmental restrictions prove to be an illusion).
For more information on the Acetic Acid business, I would recommend reviewing Celanese’s investor day materials from early May.
History with EPS Guidance – in 2015, CE set out a target EPS of $8.00-$8.50, and now expects greater than $9.00 for 2018.
Buybacks – over the past five years, CE has repurchased $1.8b of stock and paid $800m of dividends (out of $4.3b of cash flow from operations). This has reduced the share count by 15% over that period. Going forward, the company expects to repurchase an additional $1b of stock through 2020, which (at the current stock price) would increase its target EPS to near $12, from the stated $11.
Summary – I think the outlook is great for CE: they expect EPS to grow to $12 from $9 by 2020, generate $4b of cash flow (with 25% going to each of dividends, buybacks, organic growth, and M&A), and have a nice debt maturity schedule (they are under 2x net debt/EBITDA). All this for under 12x NTM EPS. Why? I think it’s just an under-the-radar opportunity that doesn’t get much attention, with an undiscovered specialty project business that should provide nice growth for the foreseeable future.
Risks – I think the main risk is that China reverses course and adds capacity again.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.