Description
***Please note all financial information in Euros ***
Rhodia Business Description
Rhodia is a French company that manufacturers a wide variety of specialty and commodity chemicals. Rhodia's products are sold to both consumer and industrial end markets, which include many industries, such as, cosmetics, detergents, pharmaceuticals, automotive, electronics, agrochemicals and construction. Rhodia has 113 manufacturing facilities worldwide and employs 23,000 people. Aventis currently owns approximately 15% of Rhodia.
Investment Thesis
The Rhodia equity represents an interesting investment opportunity to benefit from declining oil prices, improving global chemical demand and a corporate turnaround story. Rhodia equity currently trades at 1.74 and has significant upside potential. My valuation implies a price of 2.45 with upside potential of 40% from the current price.
Rhodia has three main product lines – Application Chemistry, Specialty Material and Fine Chemistry. Specialty Material is the stable cash flow generating product line. Application Chemistry is a positive cash flow product line but has seen margin compression. Fine Chemistry is the smallest product line and has had significant operational issues. Rhodia has been divesting assets from its fine chemistry product line.
Rhodia is operating in a strong chemical product demand environment. Rhodia has experienced volume growth in 2004 and has implement prices increases in the second half of 2004 for nylons. From a product demand perspective Rhodia should be operating in a desirable environment in 2005.
One of the key raw material inputs for Rhodia is Benzene. Benzene is derived from oil and has experienced significant price increases going from $1.65 a gallon at the start of 2004 to $3.95 per gallon in September. Benzene prices have declined with the recent decline in oil prices and the December benzene contracts are around $3.25 pr gallon. One has to have a negative macro view that oil prices will decline to purchase Rhodia equity. Rhodia utilizes about 156 mil. gallons of Benzene in a year. Any decline in oil prices should significant positive impact on the financial performance of Rhodia.
Rhodia has a leveraged capital structure. In 2004, Rhodia’s management undertook a restructuring and asset divestiture plan in order to improve its liquidity. The credit markets have been receptive of Rhodia’s turnaround and the 2011 unsecured bonds trade at a spread of under 400 basis points. Some equity analysts who cover Rhodia have been raising issues about near term liquidity and Rhodia’s ability to roll 2005-2006 maturities. With Rhodia’s 10 year credit protection trading at a spread of 417-430 basis points and the current demand for high yield paper, I am confident that Rhodia can access the high yield/leverage finance markets. Any new high yield deal to refinance the 2005-06 maturity will have a positive impact on Rhodia stock. The disconnect between the sell equity analysts and credit markets (and sell side credit analysts) on Rhodia short term liquidity and long term credit is significant. The credit markets are far more bullish on Rhodia. Given the levered capital structure of Rhodia, I feel significantly more comfortable with credit markets implied comfort in Rhodia’s liquidity than with sell side equity analysts doing liquidity and credit analysis.
Corporate Overview
Applications Chemistry
FY03 Sales (pro forma) 2,283.0
PPMC Coatings 523.0
Rare Earths, Silica & Silicones 721.0
Home & Personal Care & Industrial Ingredients 609.0
PPF Phosphorus Derivatives 430.0
EBITDA (before restructuring costs) 188.0
EBITDA margin 8.5%
Specialty Materials and Services
FY03 Sales 2,010.0
Eco services 213.0
Acetow 424.0
Polyamide 1,373.0
EBITDA (before restructuring costs) 326
EBITDA margin 16.2%
Fine Chemistry
FY03 Sales 626.0
Perfumery Performance & Ag. 366.0
RPS Pharma Solutions 260.0
EBITDA (before restructuring costs) -3.0
EBITDA margin -0.5%
Rhodia Capital Structure
Rhodia has a leveraged capital structure. The 10 CDS on the credit is trading at a spread of around 417-430. At the start 2004, Rhodia appeared to be heading towards bankruptcy but during the year Rhodia’s management restructured its capital structure (extended maturities and did a rights offering) that prevented bankruptcy. Given the spreads where Rhodia debt currently trades, I don’t think Rhodia should have any trouble accessing the capital markets in 2005 to roll over less than 400 mil euros of debt.
2005-2006 Maturities
6.25% 2005 Sr Notes 49.0
6.00% 2006 Sr Notes 300.0
Total Net Debt 2916.0
Common stock 627.582 mil shares
Price 12/29/2004 1.74
Equity Market Cap 1092
TEV 4008
Rhodia Valuation
Given the leveraged capital structure and turnaround situation at Rhodia, I believe that the best way to value Rhodia equity is as a residual after debt is subtracted for TEV. Rhodia will not have positive net earnings per share in 2005. Chief Operating Officer Gilles Auffret in an interview (Handelsblatt newspaper – Bloomberg story12/28/2004) stated that Rhodia plans to be profitable by 2006. “Even amid the increase in oil prices and the decline of the dollar we have reached, and partly exceeded, our restructuring targets.”
Current TEV € 4 bil. Approx (calculated of current prices)
2004E Sales 5.1-5.2 bil.
2004E EBITDA 430-450 mil.
2004E Margins 8%
TEV/2004E EBITDA 9.3x
TEV/2004E Sales .8x
Rhodia has stated that its cost reduction and cost savings target to achieve by 2006 is 323 mil. The majority of the projected cost savings coming from SG&A. Rhodia management’s medium term objective is to achieve EBITDA Margins of 13%. From COO Auffret comments it appears that the cost reduction plan is on track.
2006E Sales 5.2 bil. range – conservative estimate
2006E Margins 13% - Rhodia management’s medium term objective
2006E EBITDA 675 mil. – implied from margins
Current TEV/2006E EBITDA 6x
Current TEV/2006E Sales .8x
European specialty chemicals firms trade at approximately 6.6x forward EBITDA and .97x forward sales. Assuming that Rhodia trades at comp levels on its projected 2006 EBITDA of 675 mil. should give Rhodia a projected 2006 TEV of 4455 mil. Subtracting net debt of 2916 mil. (this assumes the 2005-06 maturities are refinanced) leaves 1473 mil. for the equity, which implies a price of 2.45 per share, 40% higher from its current price of 1.74.
Given Rhodia’s capital structure any improvement in EBITDA should significantly benefit Rhodia equity. In my valuation analysis there is no accounting for improved pricing which Rhodia has implemented, declining benzene and oil prices or improved chemical sector demand and prices. Rhodia historical peak EBITDA was around 899 mil. without including the current restructuring cost savings. If Rhodia can achieve its cost savings and with declining benzene prices (improving gross margins), Rhodia equity has the potential to double in 2005.
Investment Catalyst
Corporate Turnaround
Cost cutting initiatives are being realized on time, and are expected to aid earnings turnaround over the next 2.5 yrs; target of 323 mil. annual savings by 2006 according to the company. Cost cutting comprised of over 50 initiatives, including shut downs, admin realignment, and moving from 17 to 9 divisions.
Sales volumes on the rise for 8 of the 9 business enterprises (1 unchanged) y/y 2Q04.
Asset dispositions decreasing leverage and increasing cash; total divestiture net proceeds est. 760 mil.
New CEO, CFO and various board members provide for a fresh management team.
Debt Maturity Extension
Extending the 2005 and 2006 with a new high yield/leveraged loan deal. This should be a positive catalyst for Rhodia and remove any unwarranted fears on a new rights offering.
Chemical Cycle
The chemical cycle should be strong in 2005 absent any major global economic shocks.
Declining Benzene Prices/Oil Prices
Declining oil prices should significantly help Rhodia by reducing benzene costs. In buying Rhodia one is betting on declining oil/benzene prices.
Risk Factors
Oil and benzene prices increasing.
Global economic slowdown which reduces chemical demand.
Rhodia management is unable to achieve its cost cutting objectives.
Appendix
Some background notes on the Specialty Materials and Services segment (stable EBITDA generator)
Polyamide
Polyamide is a technical name for Nylon which is a synthetic hydrocarbon substitute for silk proteins. Nylon compounds for plastics, carpet yarn, technical fibers, textile yarn, nylon 6,6 intermediates, N salt, adipic acid, adiponitrile ("AND") and hexamethylene diamine ("HMD").
There are two categories of Polyamide products
1. Intermediates - selling into other chemical companies
2. Downstream activities - textile market, fiber (airbags, carpets), and engineering plastics (auto, appliances)
Rhodia Polyamide is focused in four sectors: polyamide intermediates, engineering plastics, high-performance fibers, yarns and fibers for industrial and textile applications.
Markets - Automotive, electric appliance, tires, ropes and nets, housing, filtration, textile and shoes
Customers - Delphi, Valeo, Siemens, Scheider, Pirelli, Sefar, DSM and Accordis
Polyamide Product Line – Positives
Integrated production of two key raw materials in polyamide 6.6: adiponitrile (ADN) and adipic acid; cost advantage.
More focused on engineering plastics and intermediates and the European market than some of its competitors.
ADN is produced at Butachimie plant (50/50 JV with INVISTA), one of the most cost efficient plants in the world, according to mgmt.
Pricing power is shifting to the producer, allowing RHA to pass through higher raw material costs more rapidly.
Polyamide / nylon prices have been raised in China and other parts of Asia (>15%).
Sept. '04 €200/ton price increase for Rhodia's PA 66 base resins and Technyl polyamide 6 & 66 compounds in Europe .
Volume up 7.2% 1H04 over 1H03, a trend up to 2000-2001 levels.
Analysts and mgmt believe prices will hold up if RM costs decline.
BASF (a main comp) has announced intention to raise selling prices for its businesses exposed to benzene.
PolyamideProduct Line – Negatives
Petrochemical prices high which results in HIGH cost of Benzene (raw material of greatest concern); increased from €450/ton to €800/ton during Q2 and RHA uses est. 620k ton/yr .
Polyamide division accounts for 80% of benzene consumption at RHA.
Acetow
Acetate filter tow -- the primary raw material used to make cigarette filters (Cellulose acetate flakes -- the main raw material for acetate filter tow ).
3 global market position in acetate tow
Monopoly / oligopoly position in cigarette filters
Rhodia has 50/50 JV with Eastman called Primester that makes cellulose acetate flakes in Brazil
Mgmt claims RHA has best cost position in the industry
Margin volatility: RM prices and FX rates -- the trend has been quarterly volatile but stable on annual basis (mgmt claim that needs to be verified)
Plants running at full capacity, according to mgmt
The main raw material is wood pulp.
Markets - Cigarette manufacturers – Rhodia sell in Europe, Latin America and Asia, but not in the USA.
Main customers - Phillip Morris, BAT and Japan Tobacco.
Main competitors are Celanese and Eastman's Voridian business. Six producers account for greater than 90% of 2003 worldwide production of filter tow
AcetowProduct Line - Positives
Sourcing raw materials from cheaper sources.
As customers "burn through" inventory, sales expected to pick back up.
Mgmt claims RHA has best cost position in the industry.
Margin volatility: RM prices and FX rates -- the trend has been quarterly volatile but stable on annual basis .
Plants running at full capacity, according to mgmt.
Global shift from non-filtered cigarettes (90% of 2003 market), along with shift to acetate filter away from polypropylene filter has stimulated demand.
Developing a new generation of filters to respond to new legislative requirements .
Catalyst
Corporate Turnaround, Improving Chemical Cycle, Declining Benzene Prices, Debt Refinancing