Description

Rhodia SA – RHA FP

Thesis

Rhodia SA (Paris: RHA FP) offers a compelling risk/reward opportunity over the next 12-18 months.  Management has materially improved the company’s financial position and product mix over the last few years and the current share price has yet to reflect the transition.  In the process, management has disposed of approx. 15 lower margin/cyclical businesses or parts of businesses.  The management team is now focused on its core, higher margin and less cyclical portfolio where it has strong market share.  RHA FP is currently trading at eur 25.  The shares were trading in the same range at the beginning of 2006 despite management’s restructuring progress.  In addition, RHA FP’s multiple discount to comps has increased.

Company Description

RHA FP is a global specialty chemicals company with positions in performance materials, functional chemicals and the organics and services clusters.  Partnering with players in the automotive, electronics, pharmaceuticals, agrochemicals, consumer care, tires, paints and coatings markets, the company offers tailor-made solutions combining original molecules and technologies to respond to customers’ needs.  Rhodia has seven enterprises: Polyamide, Acetow, Novecare, Silcea, Eco Services, Organics and Energy Services.

Polyamide

Accounting for 40% of group sales, polyamide is a main driver for Rhodia's performance.  Results in the segment have been strong, reflecting a tight supply/demand balance for upstream nylon intermediates (ADN, HMDA and Adipic Acid).  Divestitures of the commodity fibers businesses have shifted the portfolio upstream, with 45% of segment sales now in intermediates.  This was a well-timed strategic shift for Rhodia, as tight markets upstream have allowed rapidly rising raw material costs to be passed through the chain.  Management does not see any new ADN capacity until 2011 and it will likely then be one or two facilities.  There is good visibility in builds because it takes three years and costs approx. eur 300 million.  Rhodia has been successful in passing price increases on here.  On the adipic acid side, there has been no new capacity announced.  Facilities cost approx. eur 150-200 million.

Acetow

The acetow division is a leading global producer of acetate tow, the material from which cigarette filters are made.  This business is cash generative and carries high margins.  There are 3 players in the acetow business.  Recent margin issues have stemmed from currency as operations are based in Germany and priced all in dollars.  Margins were 24-28% over the past few years and down to 19% in 2007 due to currency.  Management is working on restructuring initiatives here to achieve a more normal 24% EBITDA margin given constant currency.  This will be mostly cost cutting and plant closures.

Novecare

Novecare provides high performance chemicals to a wide range of industries, from cosmetics and detergent products to the oil industry.  The business has developed niche positions and holds leading positions in a number of markets.

Silcea

Rhodia is the leading global producer of high performance silica, most of which is used in tires.  Silica reduces the resistance between the rubber and the road by 25% vs. the competing product, carbon black.  This reduced friction yields 5% savings in both fuel consumption and carbon emissions, making it an environmentally and economically attractive product.  Customers do pay for this performance, with silica commanding a 30-40% premium to carbon black.  However, the difference to the producer is negligible. Fillers (carbon black or silica) only represent 1% of a tire's production cost.  Such a niche, but critical application, allows for pricing power.

Eco Services

Eco Services is the leading company in the North American market for sulfuric acid regeneration services with eight production units at six different sites in the Gulf region, the Midwest and the West Coast.  Eco Services’ success lies in its strong emphasis on the reliability of its production, strict adherence to product specifications as well as the integrated management of its logistical network.

Organics

There are three seemingly disparate businesses in the organics segment: flavor and fragrance additives (40% of segment sales), contract TDI production for Lyondell chemical and isocyanates (40% of segment sales) and aspirin/paracetamol (20% of segment sales).  Management is committed to divesting the aspirin/paracetamol business in the next two years.  Overall, management is targeting 14-15% EBITDA margins in 2009/10.  This is from 8.5% in 2006 and 10% in 2007.

Energy Services

Rhodia Energy Services is in charge of energy supply management and production, as well as management of greenhouse gas emissions and optimization of the emission credits portfolio.  Rhodia expects to receive between 11 and 13 million tons of CER credits per year beginning in 2007 and through 2013.

Summary Financials

The following summary financials are from the 2006 20F.  Although simplified, Rhodia’s financial progress is notable.  The company has increased sales each year and improved profitability while reducing invested capital.  Net debt has been reduced by eur 713 mm and RHA FP achieved its net debt / recurring EBITDA target of <2x a year ahead of commitment.  Despite this, RHA FP shares are down 20% in 2007.  Management has reduced and restructured debt to longer maturities and lower rates with improved operating cash flow and asset sale proceeds.  Prior to the refinancing, Rhodia had major bond maturities in 2010 and 2011.  As of September 30, 2007, the maturities have been extended to 2013 and 2014.

Valuation