Description

Investment Thesis

We think Constellium (CSTM) represents a very compelling risk/reward at current levels.  The company has been written up on VIC a few previous times (most recently in January 2018) but we think the timing is now right due to a near-term positive inflection in free cash flow. These write-ups should be looked at for more background information on the company. Constellium has been investing heavily in automotive aluminum sheet capacity for the past few years. This investment has stressed balance sheet, which has turned many investors away.  However, the company is finally producing free cash flow and there should be a large ramp over the next couple of years as they harvest their investment.   

Valuation is attractive at <6x 2020 EBITDA and we see the potential for the stock to double over the next year or two without much multiple expansion.  Many investors have been turned off by high leverage (4.3x LTM EBITDA) but this should be a powerful de-leveraging story as the balance sheet reflects investments that should now start producing strong returns and cash flow.   

Company Overview

Constellium is a value-add processor of aluminum.  It produces sheet, plate and extruded products utilized in the automotive, packaging and aerospace markets.  The massive growth opportunity for the company is in the automotive market as more cars move to aluminum sheet and structures in order to lower the weight of the vehicles and meet stricter environmental standards.  The company has spent the last few years investing large amounts of capital in order to increase exposure to this long term growth market. The company reports three operating segments:

1. Packaging & Automotive Rolled Products (PARP)

- ~47% of 2018 EBITDA

- ~80% of current volume is aluminum packaging (cans) and 20% goes into the        

Automotive market

o Automotive margins are significantly higher than packaging and this is where the company is focused

• For example, the entire segment (auto and packaging) currently produces EBITDA margins of ~$280/t (the company reports in EUR but we are using USD) although this includes a drag of some production in ramp-up that is currently losing money.  The new automotive production that is ramping up should produce EBITDA margins of $800/t when at full utilization in 2021/2022.  

o Based on the segment’s automotive production ramp, segment EBITDA should increase from ~$270mm in 2018 to over $400mm in 2022 (>10% CAGR).

2. Aerospace & Transportation (A&T)

- ~29% of 2018 EBITDA

- ~55% sold into aerospace market with the other 45% sold into various transportation and industrial markets

- Aerospace should grow in-line with market (~2%) but transportation/industrial shipments are expected to grow at 6-8% CAGR through 2021

3. Automotive Structures & Industry (AS&I)

- ~24% of 2018 EBITDA

- This segment produces extruded products for automotive (~55%) and other transportation/industrial markets (~45%)

- Automotive aluminum structures demand is growing ~10% pa as it takes share from steel and the company’s automotive structure earnings should grow 

~50% to 2021

- Growth in electric vehicle production is a massive opportunity due to battery enclosures

o Electric vehicles have up to 3-5x the amount of aluminum vs. internal combustion engine vehicles

The company’s investor day last fall provided a good summary for the company’s outlook over the next few years.  As discussed, the automotive market is the source of growth. This demand should continue regardless of cyclical concerns due to the massive tailwind of aluminum taking share from steel.  Below is the company’s EBITDA walk to 2022 and it can be seen that a majority of growth is due to projects they have already spent money on and a cost improvement program: 

Valuation

In terms of valuation, we see CSTM trading at ~6x 2019 EBITDA and ~5.5x 2020 EBITDA.  This valuation includes earnings headwinds that the company is facing as it ramps up new production lines into 2021/2022.  Historically, metal processing companies have traded between 6-8x EBITDA. If we assume the company is fully ramped up in 2022 and can hit 700mm EUR in EBITDA, we see the company trading at ~4x EBITDA including deleveraging of the balance sheet through cash generation.  Assuming a multiple of 6x on 2022 and using our 2021 net debt figure, we arrive at a stock price of ~$20/share (~100% upside) over the next year or two.

Major Risks

-          There are timing risks on the company’s ramp-up but so far everything is going as well as can be expected

-          Cyclical risks are clearly present but the company’s large automotive exposure is a bit misleading due to the fact that aluminum is structurally taking share                      from steel

-       The balance sheet is clearly levered but there are no near term maturities and unless something drastically wrong occurs, they should be fine

Catalyst

  - Earnings reports showing continued production ramp and cash flow generation

  - Possibility of Arconic merging their flat rolled products (FRP) segment into CSTM via Reverse Morris Trust as Arconic has decided to spin or sell division