|Shares Out. (in M):||165||P/E||7.5||6.2|
|Market Cap (in $M):||6,100||P/FCF||7.5||6.2|
|Net Debt (in $M):||2,500||EBIT||1,325||1,500|
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Before I begin, I want to make an intro comment: CC is the stock I know better than any in the world. For a period of time, I had roughly half my portfolio in CC and it is yet again a very significant investment. Their core TiO2 business is one of the widest-moat businesses I have ever analyzed. As the stock has decent sellside coverage, I’m going to keep my write up focused on what’s differentiated in my view, but I’m happy to answer general questions in the Q&A.
Chemours (CC) is a chemical company focused on the manufacturer of TiO2, where CC is the low-cost producer, and fluoroproducts, such as Telfon and Freon.
CC is an exceptionally high-quality business which I believe can grow “mid-cycle” EBITDA at a high-single digit rate for the next three years yet is trading 7-10x EPS with only ~1.5x-2.0x net leverage. CC is the world’s low-cost producer of TiO2, where CC’s proprietary technology has resulted in double the industry’s margins over the past 50 years. The company also has a growing fluoroproducts business, where patent protection for their next generation refrigerant, Opteon, should generate significant above market growth through the mid-2020s.
The stock sold off sharply in H2 2018 with the broader chemical sector on fears around global growth as well as specific worries that the sometimes vicious TiO2 cycle was turning down. However, 1) CC’s low-cost TiO2 production generates significant cash even at cyclical bottoms (when other TiO2 producers are burning cash) and 2) half of EBITDA is generated by the significantly less cyclical fluoroproduct business where CC is growing its Opteon business. Combined, CC has substantially less earnings cyclicality than CC’s low multiple implies, enabling CC to make significant share repurchases while the other cyclical chemical peers, to which CC is being comped, must strengthen their balance sheets. Further, recent TiO2 data and utilization rates indicate the TiO2 down cycle may have played out and positive estimate revisions may be coming.
Finally, and most importantly, I believe CC’s shares are cheap even if a global crisis strikes and the TiO2 cycle returns to trough conditions. Assuming trough TiO2 conditions (where again every producer besides CC burns cash) and an arbitrary 30% haircut to fluoroproducts 2018 EBITDA, CC should still generate ~$3 in earnings and be sub-3x levered. Reasonable leverage and 12-13x “the world is ending” earnings is cheap enough for me.
Global Recession/Market Pullback – While I believe CC is cheap regardless, CC shares have historically had high beta and could trade off sharply in a market pullback
Fluoroproducts Patents – Opteon is a key growth segment for CC, yet certain key patents begin to rolloff by the mid-2020s, making true “mid-cycle” EBITDA more difficult to estimate
Lawsuits – CC historically has been perceived as a company with significant legal risks. While the previous major legal concerns have been resolved, continued lawsuits around PFOAs could result in negative headlines and stock market pressure.
Volume Stabilization/Share Loss – CC recently has been attempting to shift its sales from “at market” to long-term contracts where CC takes the volume risk but the price is fixed. As a result, CC has lost market share in recent quarters. While I doubt CC’s attempts prove successful in the next downturn, I am also not concerned with CC’s market share losses. At worst, TiO2 is a commodity and CC can gain volume back over time. At best, volume stabilization works and the whole TiO2 industry has greater profitability and visibility.
Upside – If TiO2 prices turn or flat-line in 2019, I believe CC can earn $5 or more in 2019, the high end of CC’s guidance. A 12x earnings multiple, still conservative given CC’s quality, yields $60, up ~ 60%.
Downside – If I assume the TiO2 division earns ~$400/ton, which given $100/ton in maintenance capex and a $300/ton spread vs. peers implies every TiO2 manufacturer in the world is burning cash, along with a 30% haircut to consensus fluoroproduct estimates, I reach roughly $3 in EPS. (So ~$450-$500MM in TiO2 EBITDA and ~$600MM in fluoro EBITDA, $70MM in other EBITDA, $120MM in corp. expense, $250MM in maintenance capex, $200MM in interest, 20% tax rate, 150-165MM YE2019 share count.) A 10x multiple implies $30, down 20%.
How Did We Get Here/The Setup
Switching gears to my “how did we get here” hat, CC’s stock is an exceptional opportunity at the current price because it was already cheap in summer 2018, but then sold off in-line with base chemical and TiO2 peers, which are the incorrect peer group given CC’s stock was already cheaper with significantly less-cyclical earnings, resulting in the significant misvaluation at present. Essentially, CC shares have been on a wild ride ever since the spin from DuPont and while the previous legal liabilities and excess leverage are now resolved, the significant volatility and fundamental changes were too much for the market to digest and CC shares never fully reflected their intrinsic value. When the chemical space/cyclicals generally rolled over in the fall last year, CC shares just traded inline with the group but the combined existing misvaluation along with the significant fall in cyclicals broadly created a “double whammy” that makes the misvaluation more like a “quadruple whammy” now.
The near-term setup is now 1) CC’s multiple is low due to fears of significant negative EPS revisions which I believe are unlikely to occur, which provides “theoretical” downside protection, and 2) TiO2 prices may be turning a corner, which should drive positive EPS revisions and a significant share reweighting. Medium term, CC shares can still reweight ahead of the group as the company generates significant FCF and is committed to shareholder returns via buyback – I believe CC will likely repurchase 10% of shares outstanding in 2019 if CC stays at current levels.
Current TiO2 Market Dynamics
In the fall of 2018, following two years of consistent price hikes, the global TiO2 industry experienced significant destocking and modest price deflation, with volumes down 10-20% depending upon producer and sequential pricing down 0-8% depending upon region. The key question now is whether the H2 retraction is a sign of an impending severe correction or a simple destock. My view is that global capacity is relatively tight, industry participants/consultants are claiming destocking will end in H1, and industry margins are now near or below mid-cycle, implying pricing should stabilize or increase into the seasonally strong spring/summer demand season.
Global utilization rates are in the mid-to-high 80s and there are no significant capacity additions currently in-progress. Historically, utilization rates at these levels have supported mid-cycle TiO2 margins. While channel destocking/restocking can significantly impact TiO2 prices, the global TiO2 end markets (paint and to a lesser extents plastics) are relatively stable over the cycle. Most investors are focused on the bust-boom-bust pattern TiO2 experienced from 2008-2016. However, the TiO2 cycle was relatively stable from 1990-2008, as utilization hovered in the high 80s with steady but predictable capacity expansions. (See chart below, and if it isn’t formatting, the DeLisle Site Visit slides at end of post, pages 10-12)
TiO2 margins have also contracted considerably from “peakish” levels seen in H1 2018. For instance, KRO, the median producer that reports the “cleanest” earnings, has seen EBITDA-capex margins fall from the mid-20s, clearly above mid-cycle for a competitive commodity business, to a more reasonable ~10% in Q4 2018. Cash margins per ton in Q1 are inline with late 2016/early 2017 markets.
(Again, if the above chart doesn’t format, UBS/TZMI have good materials on this.)
Most encouragingly, industry consultants report that many Chinese TiO2 producers, who are typically the high-cost producers that set “floor” prices, are currently burning cash. Chinese producers have recently put through small price hikes, which combined with industry consultants expecting firmer Q2 European prices into the seasonally strong spring season, I believe sets the industry up for better pricing in H2 2019.
TiO2 Low Cost Production
CC has been the low-cost producer since it developed the chloride-ilmenite process in the early 1970s. In overly simplistic terms, there are two main sources of titanium feedstock – ilmenite and rutile – and there are two processes to make TiO2 from the feedstock – sulphate and chloride. Ilmenite is cheaper than rutile, but ilmenite cannot be used in the chloride process. The chloride process results in a higher quality TiO2 product favored in developed markets, thus chloride TiO2 prices are higher than sulfate TiO2 prices. The one exception to the above is CC, which is the only TiO2 producer capable of using ilmenite in the chloride process. This technical know-how, which has survived fifty years of competition, combined with CC’s scale benefits (CC’s runs TiO2 lines at >5x the scale of competitors), has resulted in a consistent $300/ton cost advantage versus the median TiO2 producers (and of course a higher spread versus low-quality Chinese producers who occupy the high end of the cost curve). This $300/ton cost advantage compares vs. mid-cycle margins of ~$300/ton in EBITDA-capex for median producers, thus CC earns double the margins of competitors over a cycle and still generates significant cash flow even at extreme industry troughs such as 2009 and 2015 when most competitors bottom at modest cash burns.
CC’s dominant position as effectively the permanent low-cost producer is one of the largest moat’s I have ever analyzed. CC is so dominate in TiO2 that the FTC sued them in the late 1970s… for strategically keeping prices too low to keep out competition. (https://www.washingtonpost.com/archive/business/1979/09/18/ftc-judge-throws-out-du-pont-antitrust-case/1a56768b-8ed0-4262-a4b4-ff205abb5ca9/?utm_term=.f3fed5ef592b)
CC’s Long-Term TiO2 Outlook vs. Peers
DuPont historically ran the TiO2 division with a focus on cash dividends rather to the parent company to support growth in DD’s high-growth areas such as seeds. Now that CC is a standalone entity, the company has a runway of high ROIC of incremental capacity editions and potential large-scale capacity additions in the 2020s. CC is presently ~18% of global capacity, which has been their market share for decades. Going forward, there is no reason that CC cannot grow its TiO2 capacity at an above market rate with strong ROICs. The only other producers capable of growing capacity are certain Chinese producers benefitting from China’s lax environmental and favorable economic policies.
The point is this: every other Western TiO2 producer owns a TiO2 business that earns mediocre 10-15% EBITDA-capex margins at mid-cycle, cannot build significant TiO2 capacity at competitive ROICs, and occasionally burns cash. CC owns a 20-25% mid-cycle margin business that can growth mid-cycle EBITDA at a MSD or better rate via capacity additions, and still generates >10% EBITDA-capex margins at trough. Market participants are comparing CC to Western TiO2 producers and awarding the company a small premium on EV/EBITDA. This is apples to oranges. CC’s TiO2 outlook is wildly different than peers, half CC’s business isn’t even TiO2, and I’d argue CC trades at discount to TiO2 peers on FCF. CC is closer to a growing specialty chemical business – more cyclicality but similar growth/defensiveness in a downturn vs. mid-cycle estimates – than TiO2 peers and CC’s 7-8x EPS multiple is exceptionally wide of any company with a comparable long-term earnings forecast. While I don’t have a specific catalyst for CC to reweight, CC’s strong buyback program capitalizes on the discount while we wait.
Note: The above margin analysis ignores CC’s and others’ attempts to shift the industry towards value stabilization contracts, which would lessen the cyclicality of the TiO2 business and shift mid-cycle margins up a few hundred bps. I consider their efforts “icing on the cake” if they come true, but belief in their success is not necessary for an investment.
I will leave this brief as my view here is not particularly differentiated from Street estimates. CC manufacturers fluorochemicals (mainly refrigerants such as Freon and the next-generation Opteon) and fluoropolymers (“non-stick” chemicals like Teflon, but also specialty chemicals sold into semiconductors, autos, etc.). Ignoring Opteon, most of this segment’s profits are attributable to commodity chemicals and while volumes are relatively stable in a downturn (air conditioning isn’t cyclical…), the segment can see significant pricing pressure in a recession/cyclical destock. The segments had ~$800MM in 2018 EBITDA, 2015 trough was ~$300MM although that was before the significant growth in Opteon, which was ~$300-$400MM of segment EBITDA in 2018. Opteon is the “next-generation Freon” and contributes well above segment growth and margins due to its current patent protected duopoly (other patent held by HON) that is experiencing regulatory-driven growth in automotive. Opteon still has growth in US automotive and longer-term the stationary AC market, though at a slower pace than the last few years.
In a recession, I estimate this segment could see a 30% EBITDA contraction, which appears conservative as Opteon’s strong margins should hold in a recession. Long-term, questions remain about CC/HON’s patent portfolio. However, CC appears in a strong position until at least the mid-2020s, as competitors such as Arkema who previously were challenging the patents have withdrawn their complaints in exchange for distribution agreements. Outside of a recession, I believe fluoroproducts can grow EBITDA at a MSD to low DD rate for at least the next three years.
DeLisle Site Visit Slides
TiO2 price stabilization into summer 2019
Potential for CC to split the two businesses (doubtful but possible)
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