The Friday Findings – August 25th 2017
The Friday Findings – August 25th 2017
Thought for the week: “Sasol’s Ethylene Cost Over-Run Underscores Why We Like The Longer Term”
Upcoming Market Dates:
Greater NY: 8/30-31
- Sasol – Shocking Cost Over-Run Should Scare Off Others – Bullish for Ethylene Longer-Term
- Containerboard – Small but Strategic Acquisition for PKG – Good for All
- Weekly Winners & Losers
In its annual earnings report this week, Sasol disclosed that its U.S. Gulf ethylene and derivatives complex is now expected to cost as much as $7.5bn, and this before any possible delay or damage caused by the anticipated hurricane (though right now the hurricane is expected to hit land well to the West of Sasol). At this elevated cost, the project now looks like a very expensive mistake for Sasol, with the cost over-runs made worse by the delays and the impact on cash flows. We would need to have at least a two standard deviation swing in ethylene margins to the positive by 2020 for Sasol to make enough money quickly enough to turn the NPV of the whole thing positive. Perhaps if oil goes back to $120!
Building an ethylene plant is not straightforward, even for the very best and well-practiced, like Dow and Exxon, who along with Borealis probably have the most expertise in-house, given recent history of building. Everyone else is relying on someone else’s expertise, namely the E&C companies, which seem to be tripping themselves up every quarter with cost over-runs driven by project delays. No E&C company will give a guaranteed fixed price today, but their customers still only agree to contracts where the E&C companies have targets, bonuses and penalties (these days we only see the latter).
So, while feedstocks may be attractive in North America, the relative newcomers, Braskem (Mexico) and Sasol, are showing that you can still make a poor investment, even if the idea sounded good – we wrote comprehensively on the subject of how hard it is to make money in ethylene in May. As we have written recently, we expect ethylene to be volatile for the next year because of the timing of ethylene and derivative plant start-ups. The chart below is not updated from the piece we wrote last month, but it shows July margins that are a fraction of what would be required to justify a facility that is on- time and on budget. While the lure of US shale has lots of people looking, the practical examples should be very off-putting. This is one of the reasons why we expect a very healthy ethylene market going forward – see research published in March.
The investment controversy/dilemma today, is that LYB looks relatively inexpensive based on the longer term view, but quite expensive if recent levels of industry margins persist through the balance of the year.
PKG announced a $265M acquisition – Sacramento Container Corpartion – that expands its offering in the relatively underserved West Coast markets, particularly northern California (food/beverage/agricultural products is the biggest consuming end market category for corrugated boxes – 45% in the US). Acquired freesheet capacity will be converted to virgin linerboard.
The total transaction size is only ~3% of PKG’s market cap but this is a good example of the type of bolt-on the company has made recently, following two similar sized deals in 2016 – extending the growth trajectory and incrementally consolidating the bottom end of the still reasonably fragmented containerboard industry.
Better fundamentals, as well as further small consolidation moves from PKG and others, should help support pricing for containerboard (and freesheet if capacity is rationalized). Pricing remains well below greenfield reinvestment levels in this industry and as effective operating rates continue to rise we still see strength – we would rather buy IP, purely on valuation today, but we like this segment of packaging in general.