Price: $47.51
Shares Outstanding (in M): 74
Market Cap (in $M): 3,507
Net Debt (in $M): 650 (pro forma)
TEV (in $M): 4,157
Business Description:
W.R. Grace (“Grace”) is a Specialty Chemicals and Construction Products company that should emerge from bankruptcy this year. The Company was founded in 1854, went public in 1953, and entered bankruptcy protection in 2001 to address asbestos-related lawsuits. The conglomerate has two reporting divisions, Grace Davison and Grace Construction Products, delineating their Specialty Chemicals and Construction Products units.
- Grace Davison (70% of revenue) – Specialty Chemicals
- Refining – Catalysts sold to refiners to increase yields
- Materials – Assortment of silica-based additives and process aids used in food and beverage packaging, print media, and consumer and industrial applications
- Specialty – Catalysts sold to the polyolefin industry for plastics production
- Grace Construction (30% of revenue) – Construction Products
- Specialty Construction Chemicals – Cement additives for increased strength
- Specialty Building Products – Waterproofing and fireproofing products primarily for commercial construction
Thesis:
Grace is a very high quality business trading at a meaningful discount to fair value for the following reasons: 1) Emergence risk, 2) Obscured earnings power, 3) Cost cutting and growth opportunities recognizable upon BK emergence and 4) Concern around potential end market softness. Grace is run by a highly competent management team, has few competitors, enjoys high market share, and sells critical products that compose a low % of its customers’ cost structures. The industry is marked by high customer switching costs and high technological barriers to entry. As a result, Grace has medium-to-high pricing power and a very defensible franchise.
We believe Grace equity will trade towards fair value as the company officially emerges from bankruptcy, margins continue to expand, and end market growth persists. A buyout is not out of the question as Grace’s largest shareholder (Ted Weschler) was recently hired by Warren Buffet. We believe Grace will ultimately be rewarded with an above-market multiple as the Company’s strong competitive position and favorable business characteristics are recognized.
Bankruptcy:
Grace entered Chapter 11 in 2001 to cope with a large jump in asbestos lawsuits related to various manufactured building materials like acoustical plasters, textured ceilings, and spray-on fire-proofing. The bankruptcy process has put a fence around the asbestos liabilities and, upon emergence, all past AND FUTURE claims will be funded from asbestos trusts created during the process. Grace will not be liable for ANY incremental damages upon emergence.
Management recently stated, “Emergence looks like a Q1 event, but could get pushed out even further.” On 1/31/11, bankruptcy court approved Grace’s plan for reorganization. Now the confirmation order goes to the District Court for approval. There are two possible objections to the approval: 1) Libby claimants which would not be an economic issue for GRA, but would delay emergence. This is simply a timeline issue. 2) Debtors re: post petition interest - $100M issue ($1.50/share) and would NOT delay emergence. We believe it’s highly unlikely the District Court reverses the Bankruptcy Court’s decision.
Company Guidance:
Grace released 2013 guidance that remains well above Street estimates, yet is highly achievable. Grace expects Revenue to grow at 8-10% between now and the end of 2013. Grace compounded revenue at 10% from 2002 to 2008. Revenue fell 11% in 2009 and rose 4% in ’10. The company also projects adjusted EBITDA margins of 20% vs. 16.5% in 2010. We believe 20% may prove to be conservative. Management commentary suggests margin guidance is conservative. Also, margins only contracted 100 bps during the financial crisis in ’08.
Competitors:
- BASF
- Albermarle
- CCIC
Customers:
- Exxon
- Chevron
- Valero
- Shell
Risks:
- BK emergence risk
- Sensitivity to commodity prices
- European exposure (40% Revenue)
- Street continues to focus on GAAP figures which under appreciate GRA’s true earnings power
- Rare Earth impact on catalyst prices
- We believe rare earth prices have been a large tailwind and will turn into a modest headwind
- Management’s expectations are that a medium tailwind will turn neutral
Valuation:
In our base case we believe revenue will grow in mid-to-high single digits in ’12 and ’13. Further, we think EBIT margins expand 290 bps vs LTM. These assumptions get you to ~$5 EPS in’13. Applying 15x EPS multiple and subtracting ~$5 due to netting the positive value of the NOL against the net future asbestos liability, net pay-as-you-go pension, and other liabilities you arrive at value per share of ~$70, ~50% higher than today’s share price.
Disclosure:
We and our affiliates are long W.R. Grace (GRA) and may buy additional shares or sell some or all of our shares, at any time. We have no obligation to inform anybody of any changes in our views of GRA. This is not a recommendation to buy or sell shares. Our research should not be taken for certainty. Please conduct your own research and reach your own conclusion.