Description

Kraton (KRA US) has been written up a few times on VIC, most recently by ruby831 in April 2017 at $31/share.  I recommend reading these and their message boards as background to the company. 

Financially, the company has disappointed since its close of Arizona Chemical.  In the company’s CIM from late 2015, PF TTM 9/30/15 Adjusted EBITDA was listed at $420mm.  Adjusting for the incremental $46mm of Polymer cost saves not in that number, brings an apples-to-apples comparison of $466mm then vs. an Adjusted EBITDA guide of $370-390mm for 2019.  But the stock has generally worked.

From announcement of the deal in September 2015, shares tripled to $50+ as recently as Q3 2018 before plummeting 60%+ to a low of $19 in the December sell-off.  Shares have subsequently rebounded to today’s $35 levels in large part due to the announcement that the company is exploring a sale of its Cariflex (isoprene rubber) business unit alongside an authorized a $50mm share repurchase.  I think there’s at least 60% upside to go.

The thesis in simple: the business, ex-Cariflex is trading below 6x this year’s EBITDA (mid-point), whereas I think it’s worth closer to 8.5-9.0x.  All the while, the proceeds from the Cariflex sale (~$710mm) and RemainCo FCF generated in 2019 will bring leverage from 3.9x today to ~2x by the end of the year (assuming no share repurchases, which will not be the case).  Beyond 2019, I expect some of the company’s significant R&D budget to yield fruit in areas like automotive (injection molded soft skin interiors are being tested with Shandong Dawn Polymer) and adhesives (de-sulfurized CTO).

Note that baked into management’s 2019 EBITDA guide of $370-390mm is: heavy turnaround activity, China tariff uncertainty, and a one-time inventory de-stocking at a large Chemical (lubricant) customer ($17mm EBITDA impact).  So that sub-6x multiple probably (hopefully?) looks a decent bit lower moving to 2020 numbers.

Loop Capital’s Chris Kapsch is, in my opinion, the best analyst covering the stock.  He points to a justified 9x EBITDA multiple for the company’s Chemicals business unit (citing an implied multiple of 10.5x for NGVT’s pine business).  And for Polymers, he points to A. Schulman (with worse margins than RemainCo Polymers) getting acquired for 11.75x (albeit by a strategic that will see significant synergies).  Applying an 8.5x multiple for the remaining HSBC and USBC business, the shares are worth $64, or up 80%.

Just a note on my Cariflex valuation.  Nobody knows the EBITDA margins for this specific business, but analysts are in the 30-40% EBITDA margin range (and mgmt. called out margin expansion in its 2019 outlook).  I assume 32%.  The business has limited capital requirements, with its manufacturing lines being recently reconfigured.  Volumes grew 8% and 18% in 2018 and Q4 2018 respectively (with flattish pricing).  Management has told me they think this is “12-13ish” (multiple of EBITDA) type business.  I use 12x.  We’ll see, but I note that sensitizing the sale at between 28-40% EBITDA margins and a 10-14x multiple doesn’t make a huge difference to valuation, which under all scenarios falls in the $60-70 NAV range.

I do not hold a position with the issuer such as employment, directorship, or consultancy.

Catalyst

• Sale of Cariflex
• Share buybacks
• R&D spend yields fruit