Value Investors Club / Mexichem (Mexchem.MX)

Description

MEXCHEM is listed on the Mexbol (MEXCHEM) with sales of over US $6.7 billion and a market cap of

US $4.91 billion.

MEXCHEM is a Mexican multinational company engaged in the production and commercialization of a

diverse portfolio of chemical and petrochemical products. It operates three business segments across

41 countries with sales in 100+ countries: Vinyl, Fluent, and Fluor.

FLOUR

Owns the biggest fluorite mines in the world and has the sole rights to exploit them. In fact,

MEXCHEM’s fluorite reserves would make of MEXCHEM the second biggest fluorite producing

country, only behind China’s aggregate output.

VINYL

One or the most efficient PVC producers in the world: After completing an investment phase

MEXCHEM’s Vinyl production is ~70% integrated, and it now sources its main feedstocks in the most

efficient way possible.

FLUENT

As MEXCHEM’s aim shifts towards becoming a services company, the company recently acquired

Netafim the world leader in micro irrigation systems paving the way towards a sustainable, high

growth business with strong fundamental drivers.

Highly diversified both in its portfolio and its global presence, a consolidated position as one of the

world´s most efficient PVC producers, a high growth potential value-added portfolio, and a dominant

advantage in its Fluor division allows them to serve industries that range from construction to highly

specialized healthcare and agriculture solutions. MEXCHEM isone of the best opportunities in the

market.

CURRENT SITUATION AND OPPORTUNITY

After MEXCHEM invested in a JV—an ethane-fed ethylene cracker in Texas that started full operations

in late 2017—it became ~70% integrated for its PVC business. The location of the cracker and the

efficiencies brought by cracking ethylene with ethane, instead of naphtha (which is an oil derivative),

have made MEXCHEM one of the most efficient PVC producers in the world.

Year-end results showed a tightness environment in ethane/ethylene chains during the last months,

which, albeit temporary, has led to take a more conservative approach on the Vinyl segment.

Several new crackers started production in late 2018 (and continue in 2019), extending ethylene supply

and pushing ethylene prices down. Meanwhile, a saturated ethane infrastructure (distribution and

fractionators) intensified in the winter season, squeezing crackers’ margins. Moreover, at the same

time, the start-up of some of the new PE plants was delayed, which lowered demand for ethylene,

further narrowing margins.

Ethane/ethylene spread got closer, tightening crackers margins including MEXCHEM’s. We expect

these dynamics to normalize towards the second half of 2019 as new US infrastructure kicks in

(distribution) and market takes in the ethylene new capacity.

US has ample ethane for coming crackers, however logistical systems like pipelines and fractionator

should continue limited in 2019. However, it is important to keep in mind that we do not expect this

commodity pressure to hold in the long run, as US Natural Gas infrastructure is scheduled to start

balancing the Ethane industry in mid-2019. We expect this infrastructure ramp-up to alleviate pressure

from 2H19 and a balanced industry by 2020, as more infrastructure is scheduled to start up. There are

340 MMb/d of Ethane fractionators capacity increase entering in 2019, while there will be 217MMb/d

in demand coming from new crackers. However, by 2021 the ethane market will be comfortably large,

with ethane supply doubling demand. Which is why our long-term thesis remains unchanged, as North

America should continue to be the most efficient region in the world to produce PVC.

Ethylene prices should remain pressured; however, a possible recovery could give our estimates

additional upside. Crackers start-upsin 2019 would add ~3.1 million tons of ethylene in a market that

will consume around ~1.4 million tons, moreover unlike 2018, in 2019 coming downstream capacity

(PE, MEG, & EDC) will require large amount of ethylene which, aided by the opening of an export

capacity of 1m ton/year (Enterprise Product´s Ethylene export terminal), will make the year have a

small excess supply, or even a balanced market, depending on downstream openings for the year.

Even as Vinyl’s short-term outlook might prove to be a challenge for MEXCHEM’s results in the first

months of 2019, it is important to keep in mind that MEXCHEM is one of the most efficient PVC

producers in the world. Furthermore, the firm has focused on building sustainable competitive

advantages throughout its business segments and becoming a higher value-added services company.

POTENTIAL CATALYSTS

VINYL

We remain confident that the short-lived disruption in Vinyl will reverse soon, on account of the

following;

Ethane prices: upcoming capacity in terms of pipelines and fractionators should ease supply constrains

in the medium-term.

Caustic Soda: The current disruption is explained by an excess supply in the US market (after a

temporary production cut by Alunorte, the largest consumer of caustic soda in North America).

Ethylene prices: They should remain pressured due to the startup of new crackers (ethylene surplus),

although this would be compensated with new polyethylene (PE) and high-density polyethylene

(HDPE) crackers (demand increase).

FLUENT/NETAFIM

As MEXCHEM strives to become a service-oriented company, this segment will continue to gain

relevance. On an organic basis, it has very interesting growthopportunities as Wavin’s developments

for storm water management will be indispensable in places where space is at a premium and where

clean water is not accessible. Additionally, Fluent has other growth opportunities, with goals other

than micro-irrigation, such as Dura-Line´s offer in high-tier products & accessories for telecom projects,

its Micro Technology offerings are unmatched in the industry and Amanco a LatAm-based brand

specialized in construction, infrastructure, irrigation, water management and storage, and

geosynthetics. As the company leans more into services with higher growth potential in the Fluent

segment.

On an inorganic basis, NETAFIM was certainly a game changer, since it was a way to enter a market

with high growth, great opportunities and unbeatable fundamentals. Currently EBITDA margin for the

division stands at 12.9% as higher margin business NETAFIM consolidates and keeps improving an

EBITDA margin of 17% would be a realistic target.

NETAFIM

Strategic acquisition: Netafim will contribute with US$1 billion in revenues and US$150 million in

EBITDA through a high value-added portfolio.

Netafim manufactures and sells irrigation systems for their use in agriculture, greenhouses,

landscaping, and mining. The company offers highly specialized products and services, and it is

currently developing high-tech solutions, like Netbeat, a smart crop monitoring system. It currently

has 4.3 thousand employees and sells to over 110 countries. Netafim is the global leader in micro-

irrigation solutions, having a leadership position in the vast majority of the places where it operates.

Fundamentals for this business are unbeatable, as water scarcity, more severe drought conditions,

rising population, and a steep reduction of arable land per capita make of micro-irrigation (and,

therefore, Netafim) the clear way forward.

Micro-irrigation in numbers:

• It uses 95% less water than the most commonly used flood irrigation method.

• It can drive crop yields up to 100% higher.

• Every new 3 million Ha. covered by micro-irrigation (one percentage point of the world’s arable land)

represent a US$6 billion revenue opportunity for Netafim.

• Highly under-penetrated market: Currently, over 75% of the world’s arable land is irrigated using the

flood irrigation method, and only 5% of the world’s agriculture industry is using the super-efficient

micro-irrigation method.

FLUOR/HFC

2018 was a great year for the Fluor segment, mainly because of refrigerant gas sales. 2018 saw a lot of

regulatory changes in connection with refrigerant gases, but the main one was the deregulation of

HFC sales (which were highly regulated in the past). This led to a spike in demand for these gases,

leading to price increases. During the 1Q19 the FLOUR segment presented a flat top-line performance,

which came as a positive surprise considering the heavy demand spike for refrigerant gases witnessed

at the beginning of 2018.

Looking forward as the FLOUR segment shows it´s capacity to keep prolonging this great performance

with its especially strong moat, barrier of entry and distinct advantage controlling supply; and the

FLUENT’s segment ability to lead in high growth markets through WAVIN, DURA-LINE, and AMANCO

as well as consolidate, increase margins and penetrate the market with NETAFIM. VINYL’s rough

patch, albeit temporary, will come to passas turmoil in the segment is a temporary supply/demand

issue. The combination of this factors will lead the way for a bright future for MEXCHEM.

OWNERSHIP AND MANAGEMENT

MEXCHEM is a family owned business which for us is a big plus as we like management and

shareholdersto have their interest align,it boosts our confidence to know our capital its tied to the

family’s savings. majority owner is the Del Valle Family, they have an excellent track record of

generating value and have overseen this company’s growth in 2003 from $312 M revenues and $50 M

EBITDA to today’s impressive $6,700 M revenues and $1,200 M in EBITDA.

Management has always shown a knack for profitability constantly expanding MEXCHEM margins and

following a 4-year plan starting 2017 to takethe company from 14%-16% beyond 20%, at the start of 2019

it stands at 19.4% (remember FLUENT should still grow from 12% to 17% EBITDA margin).

On top of this management has a flawless track record acquiring and integrating companies with

NETAFIM’s acquisition a great example, leverage was pushed to a multiple of 3.1x NET DEBT/EBITDA

and by the end of 2018 their NET DEBT/EBITDA multiple stands at 2.1x.

OPPORTUNITY UPSIDE

Management has expressed discontent in the market´s perception of the company starting by its

name MEXICHEM the company is perceived as a highly cyclical EM (emerging markets) chemical

company. This could not be more wrong since countries that represented more the 5% of revenues

are:

U.S.: 17%

Mexico: 9%

Germany: 8%

UK: 6%

Brazil: 6%

India: 5%

Today specialty materials FLUENT represents 57% of revenues and 40% of EBITDA while upstream and

downstream FLOUR represents 12% of revenues and 26% of EBITDA.

VINYL being roughly 30% of the company makes the idea of a highly cyclical company strongly

mistaken.

Possible actions management could take includes a Spin-Off of its Fluent division either in NY or

London under a different name which would allowthe division to trade at EV/EBITDA multiples of >10x,

creating value for the holding company MEXCHEM.

Today Specialty material companies trade at an average EV/EBITDA multiple of 9.0x to 13.8x while

MEXCHEM trades like a commodity company at 6.1x.

Another more farfetched action management could take would be to sell the VINYL segment all

together as we can see is this document even with a completely vertical integration cyclicality can still

affect the segment. Without this segment MEXCHEM would be exposed at the Ethylene spot market

which in current market conditions would be beneficial. The way I see it, certain exposure to cyclicality

is inevitable and selling the division would be in line with the shift in MEXCHEM towards becoming a

services company and would allow MEXCHEM to trade at considerably higher multiples. VINYL should

be valued at an EV/EBITDA multiple of 6x-7x for a total value of $3,300 M to $3,850 M. With MEXCHEM

market cap currently at $4,910 M a lot of value could be created, cash could prove in handy for future

acquisitions into service and value-added businesses furthering reducing exposure to cyclicality down

the road.

WRAP UP AND VALUATION

We summarize out thesis in MEXCHEM in some key points:

 We are buying a company controlling supply by owning the largest fluorite mine in the world

the equivalent of the second producing country only behind China.

 The world leader in Micro-Irrigation a highly under-penetrated market with only 5% of the

world’s agricultural industry using the super-efficient method.

 Fast growing businesses in WAVIN, DURA-LINE, and AMANCO.

 Vinyl at a cyclical low but showing slow but steady improvements in market conditions.

 Markets mistaken perception on the business and its valuation

 Possible managerial actions that could be catalysts by selling or spinning off its subsidiaries

resulting in an enormous creation of value.

We are not factoring any of these assumptions in our valuation (5 and 6), MEXCHEM should generate

between $840 M and $910 M over the next couple of years that yield us an 8.4% free cash flow yield

today that will climb to 10% in 2020.

Leverage today stands at 2.1x EBITDA and should fall below 2x next year. The company has a share

buyback plan in place and are prepared to increase it if price remains attractive. With a Dividend Yield

of 3%.

In summary, you could be paying almost one of MEXCHEM segments and getting the other two for

free with possible catalysts for a multiple expansion.

Using a 15xP/FCF multiple yields us a price target of $73 MXN 2019 and $87 MXN 2020 implying 64% and

93% upside respectively, two years out. Current valuation metrics are 18.9% ROCE, 6.0x EV/EBITDA, 12x

P/FCF and 2.1x NET DEBT/EBITDA all 2019 in our estimates.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Company share buyback, potential listing in NY or London, results

show sort by

			2019	2020
Price:	44.00	EPS	4.2	4.6
Shares Out. (in M):	2,087	P/E	10	9.2
Market Cap (in $M):	91,850	P/FCF	12	10
Net Debt (in $M):	42,000	EBIT	0	0
TEV (in $M):	133,850	TEV/EBIT	7.1	6.5