Weekly Findings – December 16th, 2018

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SEE LAST PAGE OF THIS REPORT Graham Copley / Anthony Salzillo

FOR IMPORTANT DISCLOSURES 203.901.1629 / 203.901.1627

gcopley@ / asalzillo@ssrllc.com

December 16th, 2018

Weekly Findings – December 16th, 2018

Thought for the week: “Three Holiday Gifts in Chemicals”

  • Chart of The Week – ALB: The Right Direction and The Right Momentum
  • VSM: The Wrong Direction and The Wrong Momentum – More Reason to Buy
  • KWR – Now Comes The Hard Part
  • Weekly Winners & Losers

Chart of the Week – ALB Moving The Right Way

  • Chart of the Week – ALB: The Right Direction and The Right Momentum

Every piece of incremental news that we read on electric vehicle development, design, production and acceptance is positive. At the same time, while not the battery makers themselves (except Tesla), the major automakers appear to be making the security of battery supply a high priority, suggesting that they see this piece of the supply chain to be critical. ALB and other lithium producers should not be valued based on what they were, but what they could become and as the chart of the week shows, ALB, despite continuous capital investments, is showing the beginnings of a break-out in terms of return on capital – note that the 2014 decline was a function of the expensive purchase of Rockwood, quickly offset by the well timed and highly valued sale of Chemetall to BASF. The company is very clear in its view that incremental investments in Lithium are additive to returns on capital, suggesting that the trend in the chart should continue.

Given the cost of the Australian purchase (which has triggered a sell-off in the stock – first chart below) and the on-going capital plan for Lithium, we suspect that ALB already has a plan in place to divest its catalyst business, proceeds from which would cover both the recent purchase and the capital plan, with cash left over for some increased return to shareholders. This event would be a catalyst for upside to the stock in our view and we think it will come in 2019. There is a huge arbitrage between the EV/EBITDA value of Livent (recently spun out of FMC) and ALB, and if ALB could close half of the gap there is a 30% upside. While ALB does not look cheap on our history based “normal” model – second chart below – history is likely not the best proxy here (there is 16% upside just from assuming that current ROC is the new normal ROC – not assuming any further improvement). We see incremental share price catalysts in increasing news flow around battery demand, increased demand for lithium as we move through 2019, and a step change stock catalyst with the sale of ALB’s (physical) catalyst business, which could raise as much as $2.5bn pre-tax.

We are adding ALB to our preferred list.

  • VSM: The Wrong Direction and The Wrong Momentum – More Reason to Buy

VSM is moving in the wrong direction – confidence in the semiconductor space is down and despite VSM’s good positioning as a supplier to the industry, incremental estimates are falling, and the stock is falling also. Estimates for 2019 are down 5% from their highs of September, but the stock is 25% off its highs and VSM has meaningfully underperformed its peers since the beginning of the year – chart below. The exception is DWDP, but the underperformance here is driven by the commodity business and it is unlikely that the electronics business has had any meaningful impact on valuation. In the second chart, VSM is still in the same valuation range as its peers, although the implied multiple for New DuPont is probably higher than the multiple for the combined company today. In this analysis, the CCMP discount is a consequence of the KMG acquisition with consensus giving the company 100% of the credit for the impact on EV and less credit for the impact on EBITDA – this is a common disconnect when looking at recent or impending acquisitions.

We have, for some time, assumed that VSM and the DuPont electronics business would end up together, for a variety of reasons, not least of which would be the value added by the combination. Part of our support for VSM has been the assumption that VSM would buy DuPont Electronics in a Reverse Morris Trust – which would be a good fit and deal structure that the market likes (look at WAB and GE Transport). This may still happen, and it would still likely be a positive for VSM. However, if stand-alone DuPont attracts a higher multiple, an alternative might be for DuPont to buy VSM – get the benefits of the integration (synergies, talent, etc.) and then spinout the combined business – as VSM’s multiple falls more value might accrue to DuPont holders through the second path versus the first. Either way it makes sense to own VSM.

  • KWR – Now Comes The Hard Part

KWR received approval for its Houghton acquisition last week – after a very long wait. Now the hard part begins – integration and delivery of synergies. This is an interesting stock as valuation has already priced in some, but not all of the benefit of the deal and we have written previously that the stock had downside if the deal was not cleared. The upside from getting the integration done well is very high as while KWR has paid a full price for Houghton, it has not paid too much relative to the potential. If KWR can bring the whole company back to its trend returns, the stock is worth close to $300 per share. The immediate data reaction is for consensus to pick up the cost of the deal and not so much the benefit – chart below. We have seen this with SWK in the past as well as FUL and ALB (above). As the business integration moves forward and as synergies start to hit the bottom line, returns improve and the stock eventually moves from skeptical to understanding – this was certainly the case with SWK. We have a strong preference for FUL because we believe that the same will happen there.

KWR does not have a track record of integrating acquisitions and this is the most significant risk to the story. The next 100-120 days will be critical as KWR integrates management and builds confidence among the Houghton team – it is very hard to do this without seeing some business pullback or without missing some early opportunities. The company appears confident and we hope that management has not underestimated the hours needed to make this a great deal and a great story rather than just another “ok” one. We are giving the company the benefit of the doubt and it remains on our favored list.

  • Weekly Winners and Losers

©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. Sources: Capital IQ, Bloomberg, Government Publications.

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