|Shares Out. (in M):||105||P/E||0||0|
|Market Cap (in M):||1,239||P/FCF||0||0|
|Net Debt (in M):||2,034||EBIT||0||0|
Key Metrics Summary
Recommendation: Long Common Stock
Company: Constellium N.V.
Market Cap: EUR 1.1bn
Enterprise Value: EUR 2.9bn
Daily volume: ~ $11mm
Short Interest: 1%
Price Target: $34
% Gain to Target = 154%
CSTM benefits from (1) the secular growth in automotive aluminum usage, due to tightening environmental standards, and (2) capacity constraints at its position in the value chain due to the high costs and long lead times for greenfield capacity and an oligopolistic competitive structure. This results in a long-term period (5 years +) of double-digit EBITDA growth, with upside optionality over the next few years from pricing increases across all products as capacity utilization increases in the entire system.
Aluminum flat rolled content per vehicle is expected to increase from 34lbs in ’12 to 170lbs in ’25 according to an often cited industry consulting report (Ducker). We believe this demand could understate the degree to which aluminum demand could increase. Increased automotive aluminum demand drives CSTM’s EBITDA from ~375 million euros in ’15 to ~ 580 million euros in ’18.
The potential for price increases is not well understood by the market, and is not included in our above EBITDA estimates.
Disrupted valuation, relative to (1) CSTM’s historical valuation, (2) peer valuation, relative to growth, and (3) standalone growth prospects, due to (a) temporary missteps in its acquisition of Wise Metals in Q1 ’15 and (b) weakness in its Aerospace segment (~20% of PF EBITDA) that started in 2H14 and (c) Greece related European overhangs combined with a lack of natural investor base given the company is European domiciled but trades in the US. Given these issues are due to temporary factors, I believe this valuation discount presents an extremely compelling risk/reward and opportune entry point.
The stock price has declined from ~$32 in mid ‘14 to $11.80 currently (down ~-63%), due largely to these temporary issues and whose financial impact should reverse.
The company’s relative illiquidity and high leverage (Net Debt/EBITDA = 5x) has led to an exaggerated stock price reaction from these fundamental factors.
The company has strong normalized EBITDA-to-FCF conversion, relative to peers, due to CSTM having (1) a lower structural tax rate and (2) a higher depreciation expense/tax shield created by its asset write-ups of Wise Metals. Given industry valuations are largely driven by EV/EBITDA, this creates a greater margin of safety for CSTM’s valuation given stronger underlying FCF once capex returns to normalized levels.
Assuming an 8.5x EV/Forward EBITDA exit on 12/31/17 (higher multiple to give credit to continued long-term double digit EBITDA growth runway), and giving CSTM credit for its lower tax rate, I get to a $34 price target or ~50% IRR.
CSTM produces rolled, finished aluminum sheet and extrusions. Finished aluminum is made by (1) inserting primary aluminum/ingot into a hot mill, which rolls the aluminum flat at high temperatures, and (2) taking this hot mill product and rolling it at colder temperatures in a cold mill, creating an even thinner rolled sheet. This rolled aluminum can be used for can or industrial end markets, or processed even further in a heat treatment facility to create higher quality aluminum for use in automotive and aerospace end markets.
The North American rolled aluminum producer market is an oligopoly, and includes Novelis (45% market share), Alcoa (30%), Constellium/Wise (15%) and Other (10%).
Aluminum is sold to customers in can, automotive and aerospace end markets in typically multi-year (5 to 10 years) contracts, with varying degrees of volume commitments (minimum commitments are common for Aerospace). Pricing is quoted as a spread to the underlying commodity price (i.e., LME aluminum price), and so CSTM and its rolled-aluminum peers take no aluminum commodity risk (there is some risk in local premiums that represent freight/warehousing costs, but this can be hedged with customer contract pass-throughs). When I refer to “aluminum” in this write-up, I am referring to finished/rolled aluminum, as opposed to the primary material.
CSTM purchased Wise Metals on 1/5/15 (close date), which represented a major strategic push for CSTM into the North American can and automotive aluminum markets. Pro forma for the acquisition, Constellium’s approximate EBITDA breakout by end-market is packaging (41% of total), aerospace (19%), automotive (11%), transport (14%) and industrial (15%). The company’s sales breakout by region, PF for Wise, is Europe (61%), North America (30%), Asia (3%) and Other (6%).
Secular growth in automotive aluminum usage, due to increasingly stringent environmental regulatory standards
Aluminum usage in autos is expected to accelerate due to stricter CAFE regulations in the US, and generally stricter regulations internationally that mandate fleet-wide miles-per-gallon (mpg) targets, that can only be met through implementing a number of changes amongst which making the car lighter/more fuel efficient through increased aluminum usage is a critical component. There are major components of the car that have yet to be converted from steel to aluminum, in particular the car’s basic frame (called “Body-in-White” (BiW)).
Aluminum volume used in autos is projected by industry forecasters (e.g., Ducker, a report by the steel industry association, etc.) to increase dramatically over the next ten years. We have conducted calls with senior executives at OEMs who are in charge of meeting these environmental standards, and they agree that automotive aluminum usage will accelerate in the next few years. These experts confirm that aluminum usage is necessary to meet the standards, and that there are no major potential substitutes that could cost-effectively replace aluminum’s role in light-weighting the vehicle. In addition, due to the long planning cycle around automotive platforms, most of these decisions have already been made and cannot easily be changed. These experts stated that upcoming auto platforms will see substantially increasing aluminum content.
The Ford F-150’s success speaks to the ability to use aluminum effectively in cars, without there being any major image problem amongst consumers. The F-150 also demonstrates how few car conversions (to increased aluminum usage) are needed to support growth: at full production in ’16, the F-150 will use 350k tons of aluminum, compared to total US automotive aluminum demand of only 220k tons in ’14, an increase of 160% on overall demand.
The cost of failing to meet these standards is extremely onerous for OEMs, as a result they have consistently met environmental regulatory standards over the last few decades.
Capacity constraints in rolled aluminum at current prices, and an oligopolistic competitive structure, should lead to higher rolled aluminum prices in the future. This is not incorporated in our estimates.
Despite the anticipated meaningful increase in aluminum demand driven by autos, automotive aluminum capacity is constrained due to the high cost of greenfield capacity that cannot be justified at current auto aluminum prices. The ramp in auto aluminum demand is instead being met by conversion of existing aluminum can capacity (e.g., can packaging used for carbonated soft drinks and beer) to automotive capacity, which is economic. However, this conversion is happening at a measured pace given the industry is an oligopoly, and the largest players have committed to only converting capacity to automotive on a contracted basis by end customers. This conversion is resulting in higher capacity utilization in aluminum can as it reduces capacity in these lower profitability segments leading to higher aluminum can prices, which benefits CSTM.
At current automotive aluminum prices, the after-tax ROIC for converting existing capacity to automotive is ~23%, compared to ~6% for greenfield capacity. “Converting” capacity simply means adding a heat treatment facility to an existing plant, and feeding rolled aluminum that previously would have been sold to can customers through this new facility.
All of the automotive aluminum demand to date has been met from converting existing can capacity
Assuming all the demand for automotive capacity is met by converting can capacity, North America will run out of this can capacity over the next few years. This will likely require greenfield capacity additions to meet continued growth in automotive aluminum demand, which should lead to increased prices to induce this higher cost supply.
Automotive aluminum EBITDA per ton would have to go up to near $1,400 from current levels at around $900 to justify greenfield expansion according to the company.
Even without increases in automotive aluminum prices, the increased utilization of can capacity due to its conversion to automotive should result in increased pricing for these segments. CSTM’s EBITDA is ~40% can, PF for the Wise acquisition, and so CSTM will benefit from these can price increases.
Price increases in automotive and can aluminum are not incorporated into my base case model/price target.
Aluminum can sheet capacity is held by Novelis (45% market share), Alcoa (30%), Wise (15%) and Other (10%), so the finished aluminum market is a relatively concentrated and rational market
Alcoa and Novelis have both committed to not convert over can/industrial capacity into automotive, unless they receive firm commitments/contracts from the auto OEMs.
Company valuation is disrupted due to (1) missteps of CSTM’s recent acquisition of Wise Metals and (2) weakness in aerospace aluminum and (3) Greece related European overhangs combined with a lack of natural investor base given the company is European domiciled but trades in the US. Valuation should recover from these levels given these issues should be temporary.
Valuation is disrupted/cheap relative to history and relative to peers, when taking into consideration CSTM’s greater growth prospects
CSTM traded at 9.0x EV/Forward EBITDA in mid ’14, before the Wise Metals and aerospace issues began
CSTM currently trades at 7.2x EV/Forward EBITDA vs its closest peer KALU at 7.8x, despite having much faster EBITDA growth and greater EBITDA-to-FCF conversion.
EBITDA growth for CSTM is ~15% to 18% over the immediate term, vs KALU at 5%
CSTM’s tax rate is 30%, vs KALU at 38%. CSTM also has a higher relative depreciation expense/tax shield than KALU, due to writing up the asset value of Wise Metals
The appropriate multiple for CSTM on FY ’18 EBITDA is 8.5x EV/ EBITDA, given CSTM will continue to grow faster than KALU even after ’18. Additionally, CSTM deserves value for its higher FCF-to-EBITDA conversion (once capex reaches normalized levels).
CSTM’s acquisition of Wise suffered a few setbacks, including (1) a higher working capital balance than originally expected, which led to a higher purchase price (due to the working capital target in the purchase agreement being exceeded), and (2) lower EBITDA than expected in H1 ’15 due to Wise not having properly hedged (through customer contracts) its metal premiums inventory exposure. Both of these issues are temporary.
Wise mismanaged working capital, and CSTM believes that it can reverse much of the increase. Wise’s working capital balance is much larger than CSTM’s working capital, relative to sales/cost of goods, and so improving on Wise’s working capital does not seem like a heroic assumption.
Our diligence calls with Wise Metals’ ex-managers suggest that Wise simply did not focus on working capital as a non-public company, and that there are real areas for improvement.
Wise’s metal premiums
When CSTM or Wise purchase its aluminum raw material as an input, they pay (1) an aluminum commodity price, which is listed on the LME aluminum exchange and (2) a metal premium, which theoretically represents transportation/warehouse storage costs between an LME warehouse and the point of receipt of the metal.
Metal premiums temporarily increased in ’14, and then declined back to historical levels by mid ‘15. Metal premiums increased due to warehouses effectively cornering the market (leading to higher warehousing costs), and then reversed this increase once new regulation was put into place that effectively changed these warehouse costs back to historical levels. As a result, the metal premium increase was temporary.
Wise did not hedge its inventory exposure to metal premiums, causing EBITDA to be negatively impacted as metal premiums declined to normalized levels in ’15. Essentially, Wise’s cost of goods was being booked at the higher metal premium cost (as Wise worked its way through 2 months of high cost metal inventory), while Wise’s revenue was booked at the lower metal premium price (as metal premium prices were immediately passed through to customers). This resulted in a temporary squeeze to Wise’s margins for H1 ’15, but this is only temporary, as margins will return to normalized levels once Wise works through its higher cost inventory.
Based on our analysis, CSTM’s aerospace issues are largely temporary, and do not reflect any structural issues with CSTM or demand.
Aerospace issues in mid/late ’14 include:
Lack of capacity due to underinvestment in the last few years
Supplier change caused a 15mm EUR reduction to ’15 EBITDA
A large customer deferred orders from ’15 to ’16, causing a 10mm EUR reduction to ’15 EBITDA
The reason why these issues are temporary are:
Lack of capacity
Management is restructuring the plants with capacity constraints, including (1) changing plant management and (2) investing 40mm EUR in debottlenecking
Company expects results to show in ‘16
Supplier contract that CSTM lost was supposedly favorable to CSTM (relative to a market contract), and so this does not represent a risk that more and more CSTM suppliers come back to renegotiate
The issue is supposedly that the customer has too much inventory, and so impact on ’15 is expected to be 10mm EUR, but expect no impact on ‘16
Company guidance is that Aerospace’s EBITDA per ton is expected to return to its historical levels in the next few years, after declining in ’15.
Sell-side estimates for aerospace expect weakness to continue going forwards, and so estimates have already been de-risked
Execution risks on completing conversions at Wise on time and on budget
Execution of turnaround in aerospace
|Entry||07/01/2015 10:37 AM|
The last person to post CSTM on VIC wrote at the end, "Well, this has turned into one of the worst calls I have ever made. If anyone is looking for a case study on the importance of a management team that you can trust, look no further than CSTM."
What changed? Thanks.
|Subject||Re: What changed?|
|Entry||07/01/2015 11:23 AM|
The primary change is share price... the stock is down over 60% since late '14. In addition, CSTM has purchased Wise Metals in early '15, which gives the company greater exposure to the automotive thesis. Those are the 2 big fundamental changes since this was last discussed.
On management, we have heard that they were well respected a year or so ago, but their image has been tarnished with stock's decline. As with other management teams where yesterday's heros are today's zeros (and vice versa), we think some of this view on management is path dependent and could change.
We have done calls on management specifically, and the feedback has been that they are good operators. For example, they turned around the Ravenswood facility from losing money to becoming one of their most profitable facilities. Our concern is more around management's communication with the Street, which is somewhat lacking. CSTM gives no guidance, and so it creates these disconnects in expectations, and sets people up for possible disappointment. We do also get the sense that people have issues with IR, which is obviously separate than management.
Either way, given the company's current valuation, we believe that any views/risks around management are more than priced in.
|Subject||The quick and the dead|
|Entry||07/01/2015 11:50 AM|
Nice. You beat me by about 48 hours on posting this. The one thing I would add to your strong analysis is the insider buying in May and June. Executives and board members bought $2.1 million worth of stock in the $12 to $15 range.
|Subject||Re: The quick and the dead|
|Entry||07/02/2015 03:03 PM|
where do you see this insider buying? since they are a foreign issuer, I don't see forms 4 on the SEC site. Thanks.
|Subject||Re: Re: The quick and the dead|
|Entry||07/02/2015 03:48 PM|
CSTM is not required to file form 4's, but they do file with the authorities in the Netherlands. Here's the link showing the insider buying:
|Entry||07/06/2015 10:04 AM|
nice write up. i recall reading and hearing some noise about an equity raise here. i forgot which research shop mentioned it.
do you have any thoughts on likelyhood of an equity raise?
|Subject||Re: quick question|
|Entry||07/07/2015 09:46 AM|
Thanks. We don’t get to any need for an equity raise in our model, neither in the base case nor under our much more conservative downside case scenario. Additionally, we don’t think an equity raise is much of a risk given:
(1) In addition to our model not showing a need for an equity raise, we’ve spoken to other investors and the sell-side, and they see no need for an equity raise either. CSTM’s management team also explicitly states that there is no need for an equity raise.
(2) Based on calls with credit desks that follow CSTM, the company’s debt is something that credit investors want to own given CSTM takes no commodity risk and has exposure to growth markets. The upshot is that credit desks tell us that CSTM has leverage capacity up to the “high 6x” level, relative to current leverage of ~5x. Therefore, CSTM effectively has more debt capacity, if needed.
(3) The company has 700 of liquidity, but this excludes an unsecured revolving credit facility of ~150 that the company likely will re-secure. This revolver was temporarily removed from the liquidity calc due to a springing covenant (due to the Wise acquisition), but I believe the company will be able to get this back.
(4) It doesn’t make sense that senior management would be buying shares in CSTM right before an equity raise. This just further supports management’s statement that they believe there is no need for an equity raise.
(5) There are currently no further covenants on CSTM’s debt outstanding.
(6) There is some cushion built into CSTM’s capex guidance, and so CSTM could cut capex somewhat if needed. Again, we don’t think they will need to cut capex, but they have room to do so.
|Subject||what is going on with this stock?|
|Entry||07/15/2015 04:24 PM|
Any thoughts on the steady downdraft here? I suppose at 5x leverage, people could decide the right EV/EBITDA here is 7x and you can get down to the $7 - $8 range. 6x wipes out most of the equity. QLTY Distribution did something like this early this year, and they actually had less leverage, although perhaps it's also a lower multiple business.
I think UBS among others got the equity issuance rumor going. I guess one thing that isn't clear to me is on the equity raise, say more cost issues come up (Wise btw looks like year 1 could be really bad on high cost inventory issues, but hopefully analysts already know this by now) - can they defer cap ex for six months to give themselves some breathing room, rather than dilute? Or are they on the hook for deliveries by a certain date, so they are now essentially forced to finish plant expansions on schedule?
Any other thoughts on selling? Seemed to getting thrown out on comparatively light volume today, albeit not super-light.
|Subject||Re: what is going on with this stock?|
|Entry||07/17/2015 07:54 AM|
On the reason for the stock price decline, I think it’s a combination of illiquidity, leverage, Europe macro issues, and misunderstanding about CSTM’s lack of commodity exposure.
We have heard that a large seller has decided to exit largely because CSTM’s leverage has increased. Given how little the stock now trades each day, this seller can have a big impact. In addition, as you point out, the company’s leverage doesn’t help if there is any EV/EBITDA multiple compression. Other reasons for the stock price decline are Greek macro concerns (given CSTM is a Europe-based company), and frankly misunderstanding about CSTM’s commodity exposure (I do think that even though CSTM takes no aluminum risk whatsoever, that it gets sold off with commodity names). Look at yesterday’s Barron’s piece that somehow characterized CSTM as a primary aluminum producer, and not an aluminum converter, for evidence of how CSTM’s business may get completely misunderstood by the market.
In terms of the equity raise risk that you mention, there is no need to raise equity under the company’s current capex plan. I think the company has enough liquidity ($700mm, even if a springing covenant doesn’t come back), even under a downside scenario. There are no covenants to be tripped so no risk of losing its liquidity. The company states that they have no need to raise equity. We spoke to credit desks, and they think CSTM can support leverage to the “high 6x’s”, which we think is an indication that the company has enough room at its current 5x. While the company could lower capex in a downside scenario (e.g., there is cushion built into their total capex guidance, they could decide to go JV on some projects, and they are not forced to finish plant expansions b/c they haven’t fully contracted their volume), I want to be very clear that I don’t think there is any need for an equity raise under their current capex budget.
|Subject||Re: Re: what is going on with this stock?|
|Entry||07/17/2015 11:56 AM|
Thanks. Am I right the business is expected to turn FCF positive around 4Q16? Do you have a sense of how cap ex is expected to flow by year? I seem to remember the total investment to upgrade Wise is $700 million?
Also, I noticed AA paid 1.5 bil for RTI, or about half of CSTM's EV, but RTI only does about 1/4 of CSTM's sales. Was RTI a reasonable comp? Seems like someone would want to buy CSTM at some point - does Netherlands domicile make a sale more complicated?
|Subject||Re: Re: Re: what is going on with this stock?|
|Entry||07/21/2015 06:24 PM|
In terms of FCF generation, we get to ~ FCF breakeven by FY ’17. The company gives capex guidance by year (400 in ‘15/450 in ‘16/350 in ’17/265 in ’18) in their presentations, but I believe there is some cushion built into that guidance (even though we assume the full capex for our FCF model). This includes the 700 to 750mm (USD) investment to upgrade Wise (between ’15 and ’22) that you mention.
I hear you on the RTI acquisition, but comparing RTI to CSTM is tricky given they are different businesses and different mixes of end markets. Nonetheless, I do think an acquisition of CSTM makes sense for a much larger diversified metals player that wants to increase exposure to downstream. However, I don’t think more consolidation from existing aluminum players is feasible, given existing industry concentration is already high.
I don’t know what impact its Netherlands domicile may have on a potential sale, but would be curious to know if you look further into this.
|Entry||08/05/2015 01:44 PM|
Thank you for well written write-up, ElCid.
It appears from today's earnings announcement that there are more headwinds than anticipated at Muscle Shoals. Where do you see this putting CSTM from a liquidity perspective as well as your belief that they reach FCF breakeven by '17? Any other thoughts on their earnings announcement would be appreciated.
|Entry||08/05/2015 03:18 PM|
I'd be curious too on El Cid's thoughts also. But I'm a little surprised by the down 20% reaction here. I get that the Wise outlook for rest of year is worse than thought, and that they made a mess of due diligence on this deal. But the basic message was this is a 2015 phenomomen, which if true would mean maybe 30 mil less cash generation for 2015, or something along those lines.
Am I missing something on this? Or is it just that management has lost all credibility, and people just don't believe them when they say expect improvement next year?
I don't get much street research on this, so not sure what the sell side reaction was - what are you seeing?
|Subject||Re: Re: Re: Earnings|
|Entry||08/05/2015 03:48 PM|
Netherlands domicile doesn't help the probability of an activist showing.
|Subject||Re: Re: Author Exit Recommendation|
|Entry||11/02/2015 12:41 PM|
nychrg - do you have any thoughts here?
|Subject||Re: Re: Author Exit Recommendation|
|Entry||11/04/2015 11:07 AM|
Actually, that "Author Exit Recommendation" was posted in error. I was posting something on another name of mine on this site, and accidently closed out of CSTM.
|Subject||Re: Re: Re: Re: Author Exit Recommendation|
|Entry||02/20/2016 04:54 PM|
Since last writing about this stock, the WISE assets have significantly underperformed expectations. The original guidance for $140 million of EBITDA has been reduced to ~$65 - $75 million, driven by a laundry list of headwinds including: Aluminum hedging, Aluminum premium pass through, Raw material / Aluminum procurement and product mix.
Having said that, I still think the stock is interesting here, especially with “strategic alternatives” for WISE being considered. During the last earnings call, the CEO said that “all options are on the table”. CSTM management is expected to make an announcement, during or around the time of the 4Q’15 earnings call, on which strategic alternative they’ve decided to pursue.
As I see it, there are four possible outcomes (1) find a partner to co-invest with CSTM in Wise, (2) walk away from WISE, (3) sell WISE or (4) do nothing.
Option 1: find a partner – I think if CSTM could have their way, they’d pick this option. A partner who comes in for a 50% stake in WISE would help alleviate CSTM’s capex spend, and the proceeds from the partner investment could be used to pay down debt at the Company. By choosing this option, the longer term thesis of BiW automotive aluminum will be intact, and CSTM will still be able to participate in this secular growth story. The concern here will be valuation and whether CSTM will accept a lower valuation than what they paid for WISE.
Option 2: Walk away – This is the “rip the band-aid” off option for CSTM. Doing so would immediately lower the capex requirements and can be done in a way that does not trigger any cross impact to the CSTM bonds. I think that core CSTM (ex WISE) is worth ~$10 - $12 / share assuming 6.0x – 6.5x 2017E EBITDA. While this may be good in terms of de-risking the business, CSTM management may view this option as a last resort since they’ve already invested themselves in WISE and believe in the longer term automotive growth story of the Company.
Option 3: Sell WISE – Similar to option 1, the challenge here would be valuation. The recent underperformance of WISE makes the idea of getting back what CSTM paid for the asset ($1.4 billion) unrealistic. Any valuation less than the net debt at WISE will likely not be accepted by CSTM given their ability to take option 2 (above).
Option 4: Do nothing – While the 3 options above should prove to be a positive catalyst for the stock, doing nothing in regards to the WISE strategic alternatives will be viewed very negatively by investors.
Since the 3Q’15 earnings call, CSTM stock shot up as high as $9/share and is now trading around $5/share. I think there is still significant upside here especially with the 4Q’15 earnings call catalyst ahead.