Description

The combination of COVID-19 & an oil price crash has caused a special stock to sell at bargain basement prices: Methanex ("MEOH")

I think Methanex makes an excellent long term investment in the current price context of $12 (all units are US dollar in this write-up), with high probability to make 3-4x your money over the next 3-4 years when the economy recovers and Brent prices revert to more reasonable levels of around $50-70/bbl. Whilst methanol isn't exactly an exciting chemical as it's easy to make, Methanex is exciting because it is probably one of the best managed chemical companies from both an operational and capital allocation perspective. Given past write-ups are available to gain more insight into MEOH's history, in this write-up, I'll focus on valuation, methanol's link to oil prices, and then provide some views on oil prices in general.

Valuation

First and foremost, MX is very cheap on most metrics imaginable, provided one doesn't think that 1) oil prices will stay at current low levels forever, and 2) US gas prices surge while oil stays low. Given its various JV interests, it's not straightforward to calculate enterprise value, but at current prices, I calculate it to be $2.3bn, which compares to cumulative UFCF of $2.2bn generated between 2014 and 2019 when one excludes project capex. The current valuation also corresponds to a valuation of ~$280/mt of gas-curtailed capacity, which compares to most new-build construction costs of $1,000/mt+ for new plants such as OCI's.

Link to oil prices

Higher oil prices are key to MEOH's performance in the short run, as the US gas oversupply situation is probably not going to resolve itself anytime soon.  Don't worry, I've made my fair share of bad calls on US gas prices and I do hope that the US shale guys can limit themselves to living within their means and rewarding capital providers in the future. However, the key driver for methanol over the past 20 years, and probably for the next 10-20 years to come will be increased (Chinese) consumption of methanol as a fuel or as feedstock for the chemical industry. Methanol production is key to converting an otherwise expensive-to-transport commodity (natural gas) into a reasonably easily transportable commodity (methanol), which can compete with naphtha-based fuels and chemicals. 

China has emerged as the world's leading consumer of methanol, both as a fuel and as a chemical feedstock. Given China's dependence on imported hydrocarbons, and despite their push into almost every renewable technology imaginable, methanol is a key cornerstone of their energy policy. It makes some sense from a diversification perspective, but is also reasonable from an economic perspective when the ratio between oil and gas prices is as large as it has been for the past decade. If oil prices are (relatively) more expensive than natural gas, it becomes economically attractive to convert natural gas into something (methanol) that can replace some of the naphtha-based (and thus oil-based) production. Thus, at lower oil prices, the methanol-to-olefins ("MTO") process becomes more challenged and methanol prices thus also go lower along with oil prices.

Oil Prices

Whilst it's hard to know how low oil prices can go in the very short term, I think based on the behavior of the Saudis, in 1-2 years Brent is very likely to be back in the $50+ range. This will positively impact methanol pricing as explained above, and allow MOEH to earn something resembling its mid-cycle EBITDA levels.

From a purely economic point of view, it's hard to see prolonged periods of oil at <$30/bbl whilst maintaining the current world order. Whilst Saudi's lifting costs may well be in the low single digits $/bbl and full cycle costs are <$10/bbl as per some estimates, KSA relies on excess oil profits to fund its fiscal outlays. The IMF thinks KSA's budget breakeven is in the $80s range, although you can probably squeeze the budget here and there to lower it a bit.

Political considerations around shale aside, my personal view is that the US shale oil industry's all-in break even (at which level the corporates make money too as opposed to only showing wellhead-IRRs) is probably at $100/bbl+ overall on a full cycle basis, although the low oilfield service prices helped them lower it a bit (so maybe $70-80 if you forced me to come up with a number). As an oil CEO put it very succinctly: "Shale didn't generate free cash flow when oil was at $100, shale is not generating free cash flow when oil is at $50 (2 months back). When are they going to generate free cash flow?" Activity in the shale patch in my view has mostly been driven due to (previously) wide open capital markets, but hopefully, this madness will disappear for some years.

Risks

Ironically, the biggest risk in my view is that reduced US shale activity will reduce associate gas production, which overall is likely to lift US natural gas prices. Overall, MEOH's North America assets are probably responsible for 60% of their EBITDA with gas prices pegged to market levels. Obviously, MX's economics will also depend on oil price levels but until natural gas hits $3/mmbtu, I'm not too worried, and the various AR / RRC threads' analyses do make me think that US dry gas should be well viable there.

Iran and most of the Middle East sit on an abundance of gas, but Iranians aside, no-one has so far bothered with starting up methanol trains, whereas LNG has been a big thing. Because of abundant amounts of associated gas there, if they decided to set up methanol plants instead of LNG facilities, this would put incremental pressure on MX in the medium- to long-run.

Coal-to-Olefins ("CTO") and other technologies (say BEV / lithium) I deem less of a risk. CTO is generally high cost compared to oil- or gas-derived chains and basically has only been used when countries lost access to oil, e.g. Nazi Germany and Apartheid South Africa. Having spent some time on the lithium chain, I would think we are so far away from battery storage technology being able to fully replace all (including high energy density) uses of fossil fuels that I'm not very worried. 

Disclaimer

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Catalyst

Few hard ones as the main driver will be oil prices / macro. Management is reviewing all its options in light of the COVID-crisis, but I'm confident that they will keep doing the right things to create shareholder value.