Mitsui Chemicals, Inc. 4183 S
February 11, 2013 - 4:37pm EST by
quads1025
2013 2014
Price: 209.00 EPS NM NM
Shares Out. (in M): 1,022 P/E NM NM
Market Cap (in $M): 2,300 P/FCF NM NM
Net Debt (in $M): 4,800 EBIT 0 0
TEV ($): 7,600 TEV/EBIT NM NM
Borrow Cost: NA

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  • Chemicals
  • Manufacturer
  • Japan
  • Highly Leveraged
 

Description

EXECUTIVE SUMMARY

Mitsui Chemicals, a Japanese petrochemical producer, appears to be an attractive short opportunity.  The fundamental outlook for the Company is very negative given that it operates in the structurally challenged Japanese ethylene market which is significantly oversupplied (Company fully admits it in its annual report).  In addition, not only is the Company trading at 11.3x 2013E EV/EBITDA, well above US-based petrochemical companies which trade at an average 6.4x multiple, it is very highly leveraged with a debt / 2013E EBITDA ratio of 7.9x.  Further, the Company expects to be cash flow negative in FY 2013 and will likely be cashflow breakeven at best for years to come.  Arguably, the equity in the Company is worth zero yet the Company has a market cap of ~¥215 billion or $2.3 billion.   The Company has amortizing debt on its balance sheet and it will likely need to raise equity to satisfy is debt obligations.

COMPANY DESCRIPTION

  • Mitsui Chemicals, Inc. ("Mitsui") manufactures and markets a variety of chemical products.  The Company is organized into six reporting segments:
    • Petrochemicals (32% of 2012 Revenues) – primarily manufactures and sells petrochemical feedstocks, polyethylene and polypropylene.
    • Basic Chemicals (33% of 2012 Revenues) – primarily manufactures and sells phenols, purified terephthalic acid (PTA), polyethylene terephthalate (PET) resin, toluene diisocyanate (TDI) and other industrial chemicals.
    • Polyurethane (10% of 2012 Revenues) – develops, manufactures and sells polyurethane materials as well as coatings and engineering materials.
    • Functional Polymeric Materials (8% of 2012 Revenues) – develops, manufactures and sells elastomers, performance compounds and performance polymer products.
    • Functional Chemicals (9% of 2012 Revenues) – produces agrochemicals (insecticides, fungicides and herbicides), catalysts and medical materials (high-strength ophthalmic lens materials for glasses, etc.)
    • Fabricated Products (8% of 2012 Revenues) – develops, manufactures and sells films, sheets and non-woven fabric products for use in the fields of energy, information technology and packaging materials.

 INVESTMENT THESIS

  • Structurally Challenged Chemical Business – Mitsui’s Petrochemical and Basic Chemicals business segments, which in 2012 (March FY end) generated a combined 52% of the Company’s EBITDA, are structurally challenged and their performance should be hindered for the foreseeable future.  The revenues and margins of the Petrochemical business segment are being negatively impacted by (i) overcapacity in the Japanese ethylene industry and (ii) relatively high operating costs due to using naptha as feedstock versus lower-cost ethane.  In addition, the margins of the Basic Chemicals business segment are being negatively impacted by rising aromatics prices stemming from reduced supply.  Although Mitsui is trying to address its circumstances, the structural issues these two businesses face are unlikely to be resolved over the next several years.
  • Overly Optimistic Consensus Estimates – Consensus estimates appear too high for Mitsui and project unrealistic revenue growth and increased profitability for the Company’s Petrochemical and Basic Chemical business segments.  On February 4, 2013 the Company reported 3Q13 results and commensurately lowered its revenue and profit outlook for 2013.  The biggest negative changes in the Company’s outlook were in the Petrochemical and Basic Chemical segments.  Although consensus estimates have started to come down post the announcement, the likelihood that they will continue to be reduced over the next few months appears high and the stock should decline accordingly.
  • Excessive Valuation – Based on internal estimates, Mitsui is trading at 11.3x 2013E EV/EBITDA, well above US-based petrochemical companies which trade at an average 6.4x multiple.  If Mitsui was valued in-line with US-based petrochemical companies, the equity in the Company would be valued at zero.  Further, Mitsui management projects that the Company’s cash flow will be negative for 2013, and internal projections estimate that the Company will be approximately cash flow breakeven for the next several years, equating to minimal FCF yield.
  • Significant Financial Leverage – Mitsui has ~¥500 billion in debt outstanding, equating to a debt / 2013E EBITDA ratio of 7.9x based on internal projections.  Over 75% of the Company’s debt is in the form of loans from banks and insurance companies at interest rates ranging from 0.52% to 11.65% according to Mitsui’s 2012 annual report.  Together with the Company’s outstanding bonds, Mitsui’s total debt amortizes at a rate of ~¥50-60 billion each year through 2022.  With ~¥60 billion in annual EBITDA and ~¥45 billion in annual capital expenditures, Mitsui should be able to service its ~¥8 billion in annual interest charges but not the amortization of the debt without raising equity.

FUNDAMENTAL ANALYSIS

  • Petrochemicals– This segment primarily manufactures and sells petrochemical feedstocks, polyethylene and polypropylene.  The fundamental outlook for this business is quite negative due to the following dynamics:
    • Significant Supply/Demand Imbalance in the Japanese Market – Japan’s current ethylene production capacity is ~7.7 million tons per annum, far exceeding domestic demand of ~5.0 million tons per annum.  Historically, Japan has relied on the export market to sell is excess production.  However, China, one of Japan’s main export destinations, is now beginning to meet its ethylene needs domestically and the level of imports from cheaper suppliers is increasing, as discussed below.  Mitsui, and others in the Japanese petrochemical industry, recognize that domestic production must be rationalized and scaled back.  In response to the supply/demand imbalance, Mitsui is now working with other companies, such as Idemitsu Kosan Co. Ltd., to integrate proximate production facilities to streamline their operations and reduce operating costs.  Mitsui is also in the process of adjusting its own facilities to ensure that they achieve high efficiencies even at low operating rates.  Still, the significant and structural supply/demand imbalance in the Japanese ethylene market should force Mitsui’s Petrochemical business segment’s revenues to be low and profit margins to be close to breakeven for the foreseeable future.
    • Higher-Cost Naptha vs. Lower-Cost Ethane Feedstock – Mitsui, along with other Japanese ethylene producers, uses naptha as a feedstock.  However, according to the Company, from 2008 through 2009, large-scale ethylene production centers were established, mainly in the Middle East, resulting in the inflow of low-priced ethylene gas into the Japanese markets.  In addition, the Japanese supply of ethylene was significantly disrupted by the Great East Japan Earthquake in March 2011.  This prompted a further upswing in demand for products from overseas and allowed cheaper imports to gain a firm foothold in the Japanese market.  As the price of Brent oil has steadily increased from $40/bbl in the beginning of 2009 to $116/bbl currently, the price of naptha feedstock has increased accordingly, making Japanese ethylene manufacturers increasingly less competitive with cheaper ethane-utilizing manufacturers.  Similar to the supply/demand imbalance in the Japanese market, the structurally higher-cost nature of Japanese ethylene production should hinder the performance of the entire industry for the foreseeable future.
  • Basic Chemicals – This segment primarily manufactures and sells phenols, purified terephthalic acid (PTA), polyethylene terephthalate (PET) resin and industrial chemicals.  These chemicals are used for manufacturing a variety of goods ranging from transparent engineering plastics, to polyester fibers for clothing to beverage bottles.  The outlook for this business is relatively negative due to a structural rise in raw material costs, particularly aromatics.  Aromatics form the basis of this segment’s raw materials: PTA is produced from paraxylene, phenol is produced from benzene and TDI is produced from toluene.  However, the supply of aromatics, which are produced as byproducts of oil refining and petrochemical production, has been declining for two main reasons.  First, the amount of oil refined in the US is increasingly sourced from lighter shale oil, which yields lower quantities of aromatics than heavier oils.  Second, the US petrochemicals industry’s shift from naptha-based production to ethane-based production has also reduced the amount of aromatic byproducts.  As supplies have declined, prices have increased as can be seen in the Japanese spot market for benzene (Bloomberg: MATSBENJ) and toluene (Bloomberg: MATSTOLJ).  Meanwhile, prices for phenol and PTA have actually been in decline over the past two years as new supply has entered the market (Bloomberg: PHEMHUNA and PT1).  The rise in the price of aromatics, exacerbated by a decline in end product prices, is a structural headwind to Mitsui’s Basic Chemicals business which should negatively impact the performance of the business segment for the foreseeable future.
  • Polyurethane – This segment develops, manufactures and sells polyurethane materials as well as coatings and engineering materials.  The products from this business segment are used in manufacturing a wide variety of goods ranging from paint, printing ink, paper, adhesives, construction materials (rigid and flexible foams), elastic fibers, furniture and floor coatings, and laminates.  The outlook for this business segment is very muted.  Revenue growth for the business segment has been negative since 2010 and it has produced negative operating profits for 11 out of the last 12 quarters with the only exception being a break-even quarter.  It appears unlikely that the performance of this business will change in the near-to-medium term.
  • Functional Polymeric Materials – This segment develops, manufactures and sells elastomers, performance compounds and performance polymer products.  The products from this business segment are used in manufacturing a wide variety of goods ranging from automotive parts, electrical wire sheathing, cold and hot water supply pipes, appliance parts, sporting goods and housewares.  The outlook for this business segment is positive.  Revenue growth for the business is really driven by GDP-growth in Japan and China and EBITDA margins have remained stable at an attractive ~15%.  The business will most likely continue to perform as it has in the past.
  • Functional Chemicals – This segment produces agrochemicals, catalysts and medical materials for the manufacture of products ranging from insecticides, fungicides and herbicides to high-strength ophthalmic lens materials for glasses.  Growth in the business has been relatively stable and steady over the past 3 years and slightly exceeding GDP growth.  EBITDA margins have been stable at 7-9% annually.  This business segment will most likely continue to perform as it has in the past.
  • Fabricated Products – This business segment develops, manufactures and sells films, sheets and non-woven fabric products for use in the fields of energy, information technology and packaging materials.  The business segment has not experienced any real growth over the past three years.  EBITDA margins have been stable at 14-16% annually.  This business segment will most likely continue to perform as it has in the past.

CATALYSTS

  • 4Q13 Earnings – Estimated to be released May 5, 2013.
  • Equity raise to satisfy debt amortization obligations

 

KEY RISK

  • Permanently High Valuation Based on Book Value Metrics – It is know that the Japanese capital markets place a heavy emphasis on trading valuations in comparison to book equity valuations, as opposed to cash flows or other measures of profitability.  It is possible that Mitsui’s stock may encounter price support through a book equity valuation metric.  Book equity for the Company is currently ¥353.6 billion.  At its current price, Mitsui is trading at 0.6x book, already considered a relatively distressed valuation by certain Japanese capital market standards.  Although the Company’s stock may continue to decline, price support for the stock may enter at 0.5x book value, or ~¥173 per share.
 

PROJECTED FINANCIALS

 

 

Mitsuit Chemicals, Inc. (4183 JP)              
Operating Model                      
(¥ in billions)                        
                           
            2010 2011 2012 2013 2014 2015 2016 2017
                           
Revenues                        
Petrochemicals       364.5 434.0 459.4 453.6 453.6 453.6 453.6 453.6
Basic Chemicals       348.8 435.7 472.9 377.5 377.5 377.5 377.5 377.5
Polyurethane         145.6 144.8 132.2 142.2 142.2 142.2 142.2 142.2
Functional Polymeric Materials     86.0 106.2 114.8 132.4 135.0 137.7 140.5 143.3
Functional Chemicals       125.0 132.0 134.0 140.8 143.6 146.5 149.4 152.4
Fabricated Products       118.6 119.8 122.8 75.6 75.6 75.6 75.6 75.6
Others/Adjustments       19.2 19.2 17.9 29.1 29.1 29.1 29.1 29.1
  Total         1,207.7 1,391.7 1,454.0 1,351.2 1,356.7 1,362.2 1,367.9 1,373.7
                           
Revenue Growth, % (p-o-p)                    
Petrochemicals       N.A.   19.1% 5.9% (1.3%) 0.0% 0.0% 0.0% 0.0%
Basic Chemicals       N.A.   24.9% 8.5% (20.2%) 0.0% 0.0% 0.0% 0.0%
Polyurethane         N.A.   (0.5%) (8.7%) 7.6% 0.0% 0.0% 0.0% 0.0%
Functional Polymeric Materials     N.A.   23.5% 8.1% 15.3% 2.0% 2.0% 2.0% 2.0%
Functional Chemicals       N.A.   5.6% 1.5% 5.0% 2.0% 2.0% 2.0% 2.0%
Fabricated Products       N.A.   1.0% 2.5% (38.4%) 0.0% 0.0% 0.0% 0.0%
Others/Adjustments       N.A.   0.0% (6.8%) 62.5% 0.0% 0.0% 0.0% 0.0%
  Total         N.A.   15.2% 4.5% (7.1%) 0.4% 0.4% 0.4% 0.4%
                           
EBITDA                        
Petrochemicals       10.9 25.6 23.2 20.6 23.1 23.1 23.1 23.1
Basic Chemicals       8.1 32.9 20.6 (6.8) (11.3) (11.3) (11.3) (11.3)
Polyurethane         8.7 1.7 (7.7) 2.9 (1.3) (1.3) (1.3) (1.3)
Functional Polymeric Materials     6.0 16.8 17.2 17.9 20.4 20.8 21.2 21.6
Functional Chemicals       11.7 11.2 9.4 19.8 13.8 14.1 14.3 14.6
Fabricated Products       16.8 19.0 19.3 7.0 10.1 10.1 10.1 10.1
Others/Adjustments       1.5 1.9 2.3 2.3 2.4 2.4 2.4 2.4
  Total         63.7 109.0 84.3 63.6 57.2 57.9 58.6 59.3
                           
EBITDA Margin, %                      
Petrochemicals       3.0% 5.9% 5.0% 4.5% 5.1% 5.1% 5.1% 5.1%
Basic Chemicals       2.3% 7.6% 4.4% (1.8%) (3.0%) (3.0%) (3.0%) (3.0%)
Polyurethane         6.0% 1.2% (5.8%) 2.0% (0.9%) (0.9%) (0.9%) (0.9%)
Functional Polymeric Materials     7.0% 15.8% 15.0% 13.5% 15.1% 15.1% 15.1% 15.1%
Functional Chemicals       9.4% 8.5% 7.0% 14.1% 9.6% 9.6% 9.6% 9.6%
Fabricated Products       14.2% 15.8% 15.7% 9.2% 13.4% 13.4% 13.4% 13.4%
Others/Adjustments       7.8% 9.9% 12.6% 7.8% 8.2% 8.2% 8.2% 8.2%
  Total         5.3% 7.8% 5.8% 4.7% 4.2% 4.3% 4.3% 4.3%
                           
Mitsuit Chemicals, Inc. (4183 JP)              
Income Statement                      
(¥ in billions)                        
                           
            2010 2011 2012 2013 2014 2015 2016 2017
                           
Revenues         1,207.7 1,391.7 1,454.0 1,351.2 1,356.7 1,362.2 1,367.9 1,373.7
  % Growth         (18.8%) 15.2% 4.5% (7.1%) 0.4% 0.4% 0.4% 0.4%
                           
Cash COGS         1,144.0 1,282.7 1,369.7 1,287.6 1,299.4 1,304.3 1,309.3 1,314.4
EBITDA         63.7 109.0 84.3 63.6 57.2 57.9 58.6 59.3
  % Margin         5.3% 7.8% 5.8% 4.7% 4.2% 4.3% 4.3% 4.3%
                           
Depreciation         73.2 68.5 62.7 62.8 62.8 62.8 62.8 62.8
  Total Depreciation and Amortization     73.2 68.5 62.7 62.8 62.8 62.8 62.8 62.8
                           
EBIT         (9.5) 40.5 21.6 0.9 (5.6) (4.9) (4.2) (3.5)
  % Margin         (0.8%) 2.9% 1.5% 0.1% (0.4%) (0.4%) (0.3%) (0.3%)
                           
     Total Interest Expense       8.5 7.6 7.1 7.6 8.3 7.6 6.7 5.8
                           
Interest Income       2.9 2.2 3.3 2.4 0.1 0.1 0.1 0.1
Other Income/(Expense)       (1.0) 9.8 (1.5) (15.1) 0.0 0.0 0.0 0.0
                           
EBT         (16.1) 44.9 16.4 (19.4) (13.8) (12.4) (10.8) (9.1)
  Taxes         11.7 11.0 8.8 (5.9) 0.0 0.0 0.0 0.0
  Tax Rate         (72.3%) 24.6% 53.6% 30.6% 0.0% 38.0% 38.0% 38.0%
  Net Income         (27.8) 33.9 7.6 (13.5) (13.8) (12.4) (10.8) (9.1)
                           
Minority Interest       0.3 9.1 8.6 6.3 0.0 0.0 0.0 0.0
Preferred Dividends       0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
  Net Income to Common       (28.0) 24.8 (1.0) (19.8) (13.8) (12.4) (10.8) (9.1)
  % Margin         (2.3%) 1.8% (0.1%) (1.5%) (1.0%) (0.9%) (0.8%) (0.7%)
                           
  FD Shares Outstanding       0.8 1.0 1.0 1.0 1.0 1.0 1.0 1.0
  FD EPS         (33.04) 24.80 (1.01) (19.37) (13.46) (12.13) (10.56) (8.95)
  Growth, %       (73.7%) (175.1%) (104.1%) 1818.2% (30.5%) (9.9%) (13.0%) (15.2%)
                           
  Dividends Per Share       3.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00
  Dividend Yield, %       1.4% 2.8% 2.8% 2.8% 2.8% 2.8% 2.8% 2.8%
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

4Q13 Earnings – Estimated to be released May 5, 2013.

Equity raise to satisfy debt amortization obligations

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