Description

ORBIA ADVANCED CORPORATION (TARGET PRICE MXP$72)

COMPANY OVERVIEW 

Orbia is a Mexican company with a portfolio of specialty products and a leading presence across different regions around the globe. 

With a market capitalization figure of US$5.2 billion and a revenue generation of US$8.8 billion, Orbia offers attractive upside potential, as it trades at a valuation discount regardless of its improved margins and stronger balance sheet.

WHY ORBIA?

Back in 2018, the Company introduced a business transformation strategy and decided to change its name from Mexichem to Orbia Advanced Corporation. The plan aimed to introduce a more diversified business model and change the company investors’ perception as a traditional petrochemical company. Under the new strategy, Orbia incorporated irrigation technologies for agriculture and developed a catalog of more specialized conduits and pipe systems within the fluent business. Through the change, they pretend to benefit from the increased demand for fiber-optic networks, the adoption of the 5G technology, and broadband penetration. Meanwhile, Orbia’s traditional chemical business is expected to benefit from the adoption of lithium-fluor batteries within the manufacturing of EVs. 

So far, Orbia´s new business model has brought an operation of double-digit margin and strong FCF generation. Management has been able to deliver EBITDA margins far above peer companies for three years in a row (20% vs 17%), giving an example of the advantage of Orbia’s vertical integration and new business orientation, while positioning the firm closer to specialized chemicals that observe profitability numbers in the mid-20s’.

Orbia new corporate strategy now includes the following innovative segments:

Netafim

Orbia’s division is a leading provider of drip irrigation technologies for outdoor/indoor farming activities; therefore, it is expected to observe considerable growth going forward. Drip irrigation is only present in 3 of every 100 fields around the world, a business in which Netafim has an average market share of 33% and that is expected to see sales greater than US$9.0 billion by 2027. 

Dura-Line

The business produces conduits for electrical installations within the infrastructure industry. Through this division, Orbia offers technology with great growth potential, due to the upcoming adoption of 5G connectivity infrastructure and the ongoing development of smart sustainable cities across the globe. It is worth mentioning that a smart sustainable city is defined as an innovative city that looks for the introduction of Information Communication Technologies (ICTs).

Wavin

The segment offers water solutions for humans and is focused on the manufacturing of value-added and more durable products for the water and water-waste infrastructure. Wavin products help increase the profitability of residential and non-residential developers and have a leading presence within Latin America and Eastern Europe, two regions where Wavin observes a market positioning of 31 and 14%, respectively. 

Koura

The company has the largest reserve of fluorite across the world and thanks to Orbia’s vertical integration, it observes an enhanced profitability performance while offering a highly competitive advantage in the manufacturing of refrigerant additives. Orbia’s Koura concentrates 98% of its production in Mexico and has a market share of 18%. The latter, together with Orbia’s integrated operation gives leeway for a better pricing and margin performance than competitors, even during the low parts of the cycle.

 Vestolit

This business division produces PVC resins, and its business cycle goes in line with growth in homebuilding activity and the own pace of the global economic recovery. As for its regional footprint, Vestolit focuses on two types of markets: those with high growth potential and those where its maturing stage gives PVC consumption a stable, yet appealing growth outlook.

Ethylene is among Vestolit’s primary raw materials. It is used for the manufacturing of PVC and accounts for almost 35% of total manufacturing costs. To cope with this situation, Vestolit formed a joint venture with Oxychem to operate a cracker and produce ethylene with lower margin pressures. Since its introduction, the cracker has provided Vestolit with a clear competitive advantage and has driven Orbia to be a major player in the production of PVC around the world.  

INVESTMENT CATALYSTS

Infrastructure spending: President Biden recently approved infrastructure spending program does represent an important driver for Orbia, as North America accounts for a third of the company’s revenues and as the polymer solutions division, together with Wavin and Dura-Line segments should be backed by increasing demand for PVC. Demand for the latter should be supported by the fact that PVC does represent a more sustainable, durable, and reliable material than any other for water solutions, and the ongoing expansion of broadband connectivity.

Infrastructure spending represents more than 45% of all PVC consumption around the world and is estimated to grow at a CAGR rate of 6.3% throughout the next five years. Under this assumption, installed capacity would not be enough to meet the increasing demand and result in a supply-demand imbalance, giving Orbia the chance to reap the benefits of its clear advantage in terms of pricing and market positioning.

Electrical vehicles revolution: According to specialists, the fluor is likely to be used as a key component for solid-state EVs’ batteries. If true, this would mean a business opportunity with exponential growth for Orbia’s Koura division. It is worth mentioning that the sale of electric vehicles is currently three times the size of 2019’s sales figure, and its market penetration is expected to grow by tenfold over the next 20-years. 

ATTRACTIVE VALUATION WITH A 33% POTENTIAL UPSIDE

Orbia currently trades at an attractive valuation even on the back of its outstanding 118% upside observed since March 2020. Either through a Sum-of-the-Parts, earnings power, or DCF valuation, the company still offers an average upside potential of 33%. 

All three methodologies consider a conservative approach, as the implied valuation was modeled through a normalized EBITDA or net income figures and where perpetuity represents no more than two/thirds of the implied enterprise value. 

DCF approach: We expect Orbia to observe an average growth of almost 9% in the Operating Cash Flow during the next five years. As for the perpetuity and NPV calculation, there was considered a growth rate of 2.0% and a discount factor (WACC) of 9.5%. Altogether, the calculation reflects a theoretical EV figure of US$11.4 billion, which would represent an average FCF yield of 13.6%, as well as a price target of MXNP$82 per share.

Earnings Power: We introduce a normalized earnings figure of US$600 million and use an average multiple from a global peer sample in the chemical industry of 18.0x to assign Orbia an implied valuation of US$10.8 billion, or MXNP$76 per share.

SoP Valuation: This approach considers that each segment trades at an EV/EBITDA multiple in line with international peers, driving the fluent division to trade at 11.5x, the polymer solutions at 7.0x, and the fluor business at 8.5x while leading Orbia to trade at a multiple of 8.9x, or 7.1x when considering a discount of 20%. It is worth mentioning that we introduced such a discount as it yields a multiple more in line with the valuation figure that Orbia has averaged over the last five years.

INVESTMENT RISKS

Refrigerant prices: They have followed a downward trend due to Chinese companies producing fluorite without any environmental concerns. 

Cost Management: Oil and natural gas price fluctuations could lead to operating margin pressures going forward.

ESG considerations: The company is not still compromised to a net zero-carbon goal strategy and the manufacturing of fluorite derivatives, like fluorocarbons, has an imminent impact on the ozone layer.

FINAL CONSIDERATIONS

Orbia does represent an excellent investment opportunity, thanks to its market leadership across different regions and innovative products. Furthermore, its well-managed balance sheet, together with an elevated cash generation is likely to entourage inorganic growth initiatives and attractive investment returns in the years to come. 

Catalyst

Cash flow generation, special dividends being reinstated next calendar year, potential US or European listing.