Description

Do you think there would be strategic interest in an asset that has gross margins north of 40%, EBITDA margins north of 30%, is the only pure-play in its end-market, in which the top 3 players control 75% of the market, in an industry that has exhibited pricing power, that gross at ~1.5x GDP, with ~$550mn of NOL's? Well unfortunately you're not alone & neither am I which has been part of the problem with GRA. And while I don't want to say this time its different I think now is as an attractive entry point as there's been in the past 3 years in the name. 

GRA has been a well trafficked name by the hedge fund community ever since emerging from bankruptcy ~5 years ago and it was also written up on VIC last September by lars prior to the February spin off of GCP. That said the stock has meaningfully underperformed chemical peers’ despite being one of the few stocks in the sector to perform in line with full year guidance, likely a result of positioning and the hope for M&A post spin that has yet to materialize. As a result, the risk/reward is attractive and the catalyst path is compelling from a fundamental perspective with upside M&A optionality.

GRA is a pure play on Catalysts (77% of sales) and Specialty Silica (23% of sales). GRA produces and sells catalysts & related products & technologies used in refining, petrochemical and other chemical manufacturing applications. The business has leading share in all of its markets (in end markets that drive ~80% of sales they hold either the number one or number two market share) that it plays in and is #1 in FCC Catalysts, resid hydroprocessing catalysts, polyolefin catalysts, and specialty silica gel, while maintain #2 market share in hydrocracking catalysts, and polypropylene process technology licensing. GRA reports in two main segments 1) Catalyst & 2) Material Technologies.

From a high level the Catalyst Business creates value added products in refining & polyolefin catalysts. In refining they help their customers run their FCC or hydro processing units more efficiently. The FCC catalysts ultimately help to “crack” the hydrocarbon chain in distilled crude oil to produce transportation fuels, such as gasoline & diesel fuels, and other petroleum-based products. While in Polyolefin the catalysts they create actually end up in the final product. These polyolefin catalysts can enhance performance of a wide range of industrial & consumer end-use applications including high pressure pipe, geomembranes, food packaging, automotive parts, medical devices & textiles.  

The company pegs the Catalyst addressable market as a $16.0bn global opportunity; $6.7bn in refining growing at a 2-4% CAGR, $5.5bn in Petrochemical growing at 2-3% CAGR, and $3.8bn in polymer growing at a 3-4% CAGR. This business has extremely attractive financial metrics with a gross margin of ~42.2% and EBITDA margins of 35.7%. There are effectively 3 players that control 75% of the market globally with GREA having leading market share, followed by ALB followed by BASF. Importantly the company has also been able to exhibit pricing power as Specialty Catalysts are less than 1% of the total input costs of the customers. The catalyst business is therefore a scarce asset that holds strategic appeal for a host of potential suitors. Given the high barriers to entry in the business in order for a new player to enter the market it would very likely require an acquisition. As mentioned, GRA is the only pure-play catalyst producer which makes it standout as the most likely candidate for a potential acquirer. A variety of industrial or materials companies could exhibit interest in the business given the margin profile, and leadership positon in a consolidated market, with pricing power. GRA would also be attractive to a suitor involved in non-FCC catalyst business or in other refining businesses related to catalyst technology. Clariant is a name that often gets thrown around as a suitor, given the fact that they have a big non FCC catalyst business & have expressed interest in the FCC end market. HON has also been mentioned as potentially interested in the asset.

The FCC market generally grows at ~1-2% per year and is driven by miles driven & consumption of transportation fuels. Last year GRA won an important customer in the Middle East (the single largest refinery in the world) that only came online in July so 2017 will represent the first full year effect of that plant running full on. In the Specialty Catalyst business the company expects growth in the ~3-4% range per year with that growth driven by the use of plastics. The company sees margin expansion potential in both parts of the business (FCC & Catalyst).

The second segment is their Material Technologies segment that has ~38.8% gross margins and 25.8% EBITDA margins. The company pegs the global opportunity at ~$5.7bn; $2.7bn of which is chemical processes growing at a 3-4% CAGR, $1.3bn in Consumer/Pharma growing at a 2-3% CAGR, $1.1bn in Coatings growing at a ~2-4% CAGR, and $600mn in other growing at a 2-3% CAGR.  Their products go into additives for a wide variety of products such as architectural coatings, toothpaste, beer, pill capsules, and petrochemical gas purification. This is another attractive high margin business that shares some common chemistry with the catalyst business as well as supply chain, and manufacturing assets. Their key customers are paint & coatings companies, consumer products companies, plastic manufactures & pharmaceutical companies.

In terms of standalone valuation I prefer a SOTP methodology given the difference between the Catalyst Business & Material Segment. I value the Catalyst Business at ~11.5x EBITDA  & the materials business at ~8.5x which leads to a SOTP target of ~$83 vs $67.57 last. The real upside comes in the form of an M&A transaction. Recent transactions in the space have been done in a range of ~12.5x-15.0x EV/EBITDA & given the scarcity value & margin profile I would assume GRA would fetch a multiple near the top end of that range. At r~14.0x EV/EBITDA GRA could fetch north of $100/sh or ~45%+ upside from current levels.

As a result of the bankruptcy GRA has ~$500mn in PV of NOL’s which equates to ~$7/sh. Backing out the NOL value out of GRA’s EV the stock si currently trading at ~10.0x ‘17E EV/EBITDA which si a slight discount to the specialty chemical peers despite a superior margin profile, growth outlook, and pricing power.

Catalyst

GRA will be a laggard to leader favorite amongst speciality chemical investors with upside M&A optionality which will draw interest from the event driven community.