Chemicals Monthly – Summary – Not the Best of Times

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SEE LAST PAGE OF THIS REPORT Graham Copley / Anthony Salzillo

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November 1st 2018

Chemicals Monthly – Summary – Not the Best of Times

  • This report contains a summary for the month, recommendation changes etc., and the accompanying two PowerPoints focus on the large cap and SMID data respectfully.
  • Popularity has waned for even the best of stories in Chemicals over the last two months, with October showing a continuation of the rout seen in September.
    • Within our broad coverage universe 8 of the worst 12 performers since September 1st were chemical companies – Exhibit 1.
    • The unhappiness with TiO2 continues – with TROX, VNTR, CC and HUN impacted, and underperforming the paint companies which have been the incremental source of bad news
  • IFF has been the best performer over the last couple of months, getting a boost from closing the Frutarom deal and the associated positive revisions to earnings – more to come.
    • PX was a good story until it was delisted on the last day of the month, pending trading as Linde PLC on November 1st
  • US companies that have reported to date have shown very mixed results, but still the majority have beaten both earnings and revenue expectations – which has generally not had much of an impact on stock prices.
    • Guidance has been incrementally more negative on expected cost increases and on lower customer orders because of seasonal destocking – although we sense that the year-end de-stocking argument is being played up this year versus prior years.
  • Outside of commodities (TiO2 and Caustic in particular), the US industry is not in bad shape and some select stories are working – especially where there is M&A activity (hence our recommendation bias)
    • Our deal driven preferences include FUL, DWDP (although momentum here could be negative for a while) as well as intermediates names which look likely M&A candidates and are now much cheaper! TSE, CC, HUN, EMN, WLK (cyclical bottom buyer), KWR
  • The SMID group has meaningfully underperformed the core sector in October, and many valuations look interesting. Everything we like has underperformed – so is a better buy today! VNTR hard to resist at this price despite HUN selling pressure.

Exhibit 1.

Source: Capital IQ and SSR Analysis


The Chemical sector has had an appalling last two months; and as of the end of October only PX, PAH, MOS, ECL, KMG, CF, RPM and ASH are in positive territory for the year; with PX, RPM, PAH, ASH and KMG driven by transactions and/or activism rather than industry fundamentals. The loss of confidence in the group is in part due to rising costs and in part due to a concern over the robustness of global growth in the wake of what is yet an unresolved trade debate. Q3 has seen more negative surprises, thus far in the reporting season versus Q2, consistent with the broader Industrials and Materials space, but with roughly half of the group reporting the bias is still positive – Exhibit 2. What has been less positive has been guidance, with BASF particularly negative and there is clearly a squeeze between raw materials and chemicals pricing in Europe that has intensified in October. LYB saw a significant step down in its European olefins and polyolefins business profits in Q3, despite producing an overall earnings beat.

Exhibit 2

Source: Capital IQ and SSR Analysis

Goodbye Praxair: Missing from Exhibit 2 is Praxair, which left our universe on October 30th – only to reappear as Linde on November 1st, with the 24-hour gap messing up many of our models this month. But the company at least went out at the top as the share price chart below shows. The company also exited on an improving return on capital trend – Exhibit 4. It had been our favorite stock pick within Industrials and Materials in 2018 and at the time of the merger was a top quintile performer for the year, although only up a little under 8%, but still well ahead of the market.

There will inevitably be some initial noise around the merged company, as the numbers will likely be a bit messy for a couple of quarters and the dual listing may force some selling from those with restrictive mandates. However, we still see the combination as one of the most attractive stories in the space, with growth coming from:

  • Synergies
  • Buyback
  • Faster organic growth than peers

Exhibit 3

Source: Capital IQ and SSR Analysis

Exhibit 4

Source: Capital IQ and SSR Analysis

SMID Collapse

We have seen something of a SMID collapse over the last few weeks with the very small cap stocks – sub $1bn in market cap destroyed in October – Exhibit 5. There have been a couple of earnings warnings and the TiO2 names all fit in either the small group or the $1-5bn group – if not, they are heading there rapidly. The smaller cap groups are looking very inexpensive – especially relative to the larger cap names in the sector. We still believe that the space in general is ripe for further M&A, but the recent step change in values may delay discussions as appropriate multiples are revisited. There appears to be an evolving lack of interest in this sub-group and it is unclear to us whether this is just cyclical or something more secular – more work to do here – if it is more secular the group becomes ripe for PE intervention – or should look for M&A opportunities more aggressively.

HUN discussed its interest in selling its stake in VNTR during its conference call, which, together with a poor quarter from VNTR has the stock now at around a quarter of what it was worth at the time it was spun out and a tiny multiple of EBITDA. Given its EBITDA potential, HUN might be better served by buying back the company. If not, HUN is likely to sell its stake in a block deal and VNTR will likely outperform on the news.

Exhibit 5

Source: Capital IQ and SSR Analysis

There are now some real bargains in the group based on both EBITDA multiple and expected EBITDA growth, although much of the opportunity requires a belief that TiO2 is not going to collapse – see VNR comments above. Exhibit 6 shows valuation versus expected growth but excludes the handful of names that have no coverage and therefore no forward estimates.

Exhibit 6

Source: Capital IQ and SSR Analysis

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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