Description

Ecovyst Inc. (ECVT)

Price:  $9.50

Mkt Cap: $ 1.2BN

Ent Val: $2.0BN

EV / EBITDA:  7.4x 2022E, 6.5x 2023E

ND / EBITDA:  2.8x

Price / FCF:  10-12%

EV / ULFCF: 8-9%

Price Target:  $14 + (trading), $25-30 (long term / transaction)

Situation Analysis

Ecovyst (“ECVT” or the “Company”) is a newly focused global provider of specialty chemicals, catalysts and services.  2,000 customers, 10 manufacturing facilities and 880 employees.  ~75% of sales are in North America.

~75%+ of sales are directed toward sustainable solutions and services:  1) Clean Air (removal of sulfur in diesel and NOx from emissions, 2) Plastics Circularity (catalysts to produce lighter and more durable plastics and enablement of chemical recycling; and 3) Renewable Fuels & Materials (improved fuel economy through alkylation and biomass transformation into fuels and synthetic rubber).  

At present, ECVT trades at an appreciable discount (6.5x fwd. EBITDA) to its specialty chemical and industrial services peers (10x-12x EBITDA) and features superior EBITDA growth (10-12%), margin (35%-40% EBITDA margins, 2x peers) and cash flow conversion (~75-80%) characteristics.

ECVT has leading market share (#1 or 2) in ~90% share in consolidated end markets with minimal competition.

The Company’s predecessor, PQ Corp, was a CCMP Capital portfolio company (a levered combination of disparate assets) that went public in 2017. Over the years, PQ underwent a series of actions (divestitures, deleveraging and special dividends paid to shareholders) which culminated with ECVT in its current form.

To date, ECVT has only reported 3 quarters (all strong) as a standalone business.  The sell side (which is legacy PQ Corp. coverage) has yet to become fully constructive on the stock with price ranges in the low to mid-teens.

If PE overhangs are not for you then you should probably stop reading here. However. I think this overhang (unlike several PE-owned public equities) is unique and presents a compelling opportunity to own an incredibly mispriced stock (DD% FCF yield) with tremendous upside potential for longer-term shareholder value creation.   

CCMP’s investment in PQ / ECVT has reached its end of life (~7 years).  Pro forma for a secondary offering announced last week at $8.75 (where the ECVT repurchased ~5% of total shares outstanding from CCMP), CCMP currently owns ~24% of the Company down from ~39% a year ago.  

o    UK chemicals conglomerate INEOS (run by Sir James Radcliffe, one of the richest men in the UK) owns 18%.  While INEOS sold stock in late 2021 but not recently, an ECVT board member affiliated with INEOS has been actively purchasing a material number of shares ($365K in 8/22 and $473K in 11/21).

In January of 2022, Dealreporter reported that ECVT was working with GS on a sale and was “engaged with a very small group of potential buyers, mainly financial sponsors” and strategic interest in the company is “expected to be limited”.  For whatever reason (state of the capital markets at that time, wide bid-ask, potential anti-trust issues with strategic combinations), a transaction was never consummated.   

In April of this year, ECVT affirmed its 2022 guidance and announced that the CEO who led the restructuring of PQ would be replaced by the Kurt Bitting, President of ECVT’s largest division, Ecoservices, who helped grow EBITDA in that segment over 60% in 7 years.

o    ECVT also announced three new board members including David Bradley (fmr. CEO of Nexeo, sold to UNVR IN 2019) and Kevin Fogarty as Chairman (fmr. CEO of Kraton which was sold in March of 2022).

o    CCMP board membership shrunk from 3 to 2 so it now seems that ECVT’s refreshed board of directors will work on behalf of public equity shareholders and less for the PE sponsor.  

In addition to management changes, ECVT announced a revised capital allocation strategy to include a $450 million stock buyback plan (vs. current market cap of $1.2BN) over the next four years. 

o    Pro forma for the 5% ECVT share repurchase, The Company is levered around 2.8x Net Debt / EBITDA.

o    ECVT will generate over ~$160MM of unlevered FCF this year on an EV of $2BN ($1.2Bn mkt cap + .8BN of net debt), with an 8% unlevered FCF yield and 11%+ to the equity (~$140MM, ex W/C changes).

After strong Q2 results and the secondary, nine directors and officers cluster purchased $1.2MM of stock on the open market in the $8.77 to $8.93 range.   

While there is not one pure play comparable in the market, we think that aspects of the business are comparable to higher quality / margin specialty chemical peers (IOSP, KWR, NEU, ASH) that trade in the 9-14x EV / EBITDA range and to some industrial services companies (APD, LIN) that trade in the 13-15x EV / EBITDA range. 

o    Given that ECVT trades at only 6.5x EV / 2023 EBITDA, there is a sizeable runway for a multiple rerating.  

o    A relevant transaction was the acquisition of WR Grace in Q321 for 3.6x revenue and 21.6x TV / EBITDA.

We think that if ECVT continues to execute on its plan (company has not missed numbers since Q318), we think fair value for the stock is $14-18 and longer-term (or in the event of a takeover), ECVT could be worth as much as $25-30 a share.

Business Overview

Geography:  84% North America, 8% Europe, 5% Asia, 3% ROW. 

End Markets:  46% Fuels and Emission Controls, 31% Packaging and Engineered Plastics, 12% Industrial and Process Chemicals, 11% Natural Resources

Customers:  Large industrial companies including Exxon Mobil, BASF, Unilever and global catalyst producers including Albemarle and W.R. Grace.  Long-term relationships with top 10 customers that average more than 50 years.  Top ten customers represent 41% of sales, with one representing 11%.

Division Overview  

Ecoservices (46% of sales / 71% of EBITDA)

o    80% of segment sales are secured by long-term contracts (5-10+ years) that include a pass through of raw materials, labor, energy and freight costs. 

§  Contracts feature minimum volume protection and / or quarterly price adjustments for items including commodity inputs (sulfur), labor and energy indexed costs.

o Clean Fuels (~32% of sales, ~5% industry growth rate)

§  Leading provider of end-to-end sulfuric acid recycling services to produce alkylate, an essential gasoline component for lowering vapor pressure and increasing octane to meet stringent gasoline specs and fuel efficiency standards.   

·         Alkylate is among the highest value and margin byproducts of the refining process.

§  Key market drivers for alkylate include refining capacity, miles driven as well as regulatory demand for cleaner and higher performance fuels.

·         During the great recession, this business managed to continue to perform and generate stable cash flow.

§  Strategic location of plants in key refining regions (concentration in CA and TX), contributes to highly efficient and sticky supply chain networks with customers. 

·         Product is shipped by barge (26%), truck (30%) and rail (24%) and in many cases via a captive pipeline (20%) connected to refinery customers.

§  Given strategic presence and decades long relationships with leading refiners, competition is limited. 

·         In North America, Chemtrade and Veolia provide comparable services.

o Industrial (~28% of sales, ~4% industry growth rate)

§  Leading producer of virgin sulfuric acid for automotive, electronics (silicon wafers), water treatment, mining (lithium, copper, etc).

·         Automotive rebound and vehicle electrification and green infrastructure are drivers for materials mining.

o Catalyst Activation / Waste Treatment (~7% of sales, ~20% industry growth rate)

§  Increasing demand for sustainable waste solutions and treatment services.  

Catalyst Technologies (34% of sales / 29% of EBITDA)  

o    ECVT is either the sole or dual supplier to global customers under various term agreements up to 10 years for polyethylene and silica catalysts.   

o    Within this segment, ECVT’s operates a 50% interest in the Zeolyst Joint Venture with Royal Dutch Shell (since 1988). ECVT operates a mix of evergreen and term contracts with value pricing from 1-3 years to supply catalysts for refining, petrochemical and NOx control catalysts for diesel transportation. 

o Polymers (~14% of sales, ~6% industry growth rate)

§  Silica catalysts that improve durability of plastics and nylon.  Demand for ECVT silica catalyst is outpacing industry demand for polyethylene (~10%+) as there is a heightened demand for lighter, stronger and more sustainable plastic products.

§  Principally competes with W.R. Grace and BASF in this segment.

o Clean Fuels / Air (~15% of sales, ~20+% industry growth rate) / Zeolyst JV

§  Hydrocracking, petrochemical and emission control catalysts that improve performance and fuel efficiency.  Increased conversion for refineries for renewable diesel. 

§  Demand for such renewable diesel catalysts is growing at a CAGR of 24% through 2025.

·         Renewable fuel sales tripled in 2021 vs 2020.

What is of Value? / Investment Case

Leading Market Positions in Key Sectors that Feature Above Industry Growth Trends

o    HSD % growth opportunities driven by demand for environmental sustainability and energy transition:  cleaner air, improved fuel economy, lighter plastics, enablement of recycling and cleaner carbon footprint.

o    Innovative and proprietary technologies with more than 90% of R&D budget allocated toward sustainable solutions.

o    Number 1 or 2 supplier in more than 90% of end markets.

Strong Visibility, Stable Margins and Sustainable Cash Flow Generation Across Cycles

o    Nature of long-term contracts with volume minimums and the ability to pass through material, labor, freight and energy costs in many cases provides margin stability and stable cash flow. 

o    EBITDA margins are sustainable in the mid to high 30s with minimal capital requirements.

o    High cash flow generative businesses with excellent visibility. Consistent 70%+ EBITDA to cash conversion with a 2025 goal to approach 80% which translates into $2.25 a share of free cash flow.

Mispriced Valuation on a Relative and Absolute Basis

o    Relative to comparable high quality specialty chemical and industrial services companies, ECVT trades at an appreciable discount to peers with superior growth and margins, providing a considerable margin of safety and opportunity for equity upside with continued management execution.

o    On an absolute basis, ECVT trades at a very reasonable LDD% FCF yield with strong visibility.

o    Management’s recent cluster purchase of ~$1.2MM of stock on the open market supports this view.

Strong Commitment to Effective Capital Allocation

o    Management seems committed to removing the CCMP PE overhang with its recently announced $450MM share repurchase program over the next four years.

o    Given modest leverage on the balance sheet (2.5x) and high cash generative nature of its businesses, ECVT has a compelling opportunity to remove the PE overhang and with increased visibility and continued execution could drive a substantial multiple rerating.

Risks

Inability to Pass Through Commodity Prices to Customers

o    While this has yet to be a scenario that ECVT has encountered, as most contractual arrangements contemplate full pass through of materials costs, market disruptions due to extreme commodity price volatility (sulfur, primarily) could pose as a tail risk.

PE Overhang May Keep a Lid on Valuation

o    While it was certainly frustrating to see the PE firm selling stock at a 20% discount to where ECVT was trading after solid earnings and guidance affirmation, our sense is CCMP is ready to move on and that new management and the refreshed board is committed to creating value for the public shareholders.

o    It is possible that another financial or strategic partner could buy out their stake and even more likely that eventually the business is eventually sold outright.

o    Regardless, as PE ownership becomes less prevalent and management inches closer to their long-term goals, we think the stock will begin to rerate.

Full Conversion to Electric Vehicles from ICE

o    While I do not view this as a material risk, some bears may point out that if the world tips over to electric vehicles from internal combustion engines, this may pose a threat to alkylate pricing longer-term and affect the ECVT’s terminal value.  In this extreme example of this happening however, ECVT’s virgin sulfuric acid business would benefit due to increased mining of EV-related materials.

Valuation Considerations

On all metrics, ECVT trades at a steep discount to comparable specialty chemical and industrial services peers.  We think largely due to 1) Its short existence as a stand-alone company, 2) An underappreciation of the strong fundamentals of its end markets as well as; 3) An underappreciation of the visibility, margin and cash flow characteristics of the business.

On a trading basis, comparable peers trade 9-14x EBITDA.  We think it is important to also consider non-specialty chemical industrial services companies including Air Products, Linde and Air Liquide when considering valuation.

2022 guidance:  sales growth of ~20%, EBITDA growth of ~16%, adj FCF growth of ~30%

ECVT has laid out a 2025 plan to achieve $1BN+ of total sales, 10-12% adj. EBITDA growth, 35-40% EBITDA margin with 80% cash conversion and is well on its way of achieving such goals.

It is important to note that revenue growth is not a meanginful metric as it often include material pass through. In this case, EBITDA and EBITDA growth are more relevant metrics to consider.

Catalyst

Elimination of PE Overhang

Continued Management Execution

Realization of Quality of Business