HON - AdvanSix: Interesting Territory Again (Rating Upgrade)

2023-05-10 17:45:03 ET

Summary

• Shares of AdvanSix Inc. shed 20% in the time frame of a quarter amidst uncertainty in global economies.
• I like the reset in the valuation after a reasonable first quarter.
• This is still a commodity business, but appeal starts to emerge again for AdvanSix Inc. at these valuations.

By mid-February, I concluded that shares of AdvanSix Inc. ( ASIX ) were muddling through as it ended a strong year 2022 on a softer note. While earnings power was relatively solid, net capital investments appeared substantial going into 2023 and could have eaten significantly into cash flows.

Valuations looked reasonable, but based on cash flows it was hard to become too upbeat on AdvanSix Inc. shares, as I feared a cyclical element as well.

Some Background

AdvanSix was spun off from its former parent company Honeywell International Inc. ( HON ) back in 2016. The company is a producer of ammonium sulfates, nylon and chemical intermediates. These are typically commodity markets, although that strong correlations between input and output costs hedge some of the volatility, although there was still plenty of volatility witnessed on the bottom line.

At the time of the spinoff, the company was a $1.5 billion business which generated $200 million in EBITDA and about a hundred million in earnings, equal to $3 per share. Based on this outset, investors quickly valued shares at $40 per share. While the earnings multiples seemed reasonable, there was the element of cyclicality, poor cash flow conversion (amidst large upgrades needed) and increased focus on ESG practices (on which the company was not performing well).

Shares actually fell to the $20 mark pre-pandemic as the business was stagnating, yet following the pandemic the business came back to life. 2021 sales rose to $1.7 billion, a year in which EBITDA rose to $255 million with earnings reported at $140 million, for earnings equal to $4.81 per share! Following upgrades made in the years before and net debt being down to $120 million, the company was in a better position, as the company announced a $100 million deal for Amines at the time as well.

2022 was tricky amidst many moving parts, increased economic uncertainty and inflationary pressures. After a peak at $55 in spring of 2022, shares fell to a $32-$42 range ever since. The peak in spring of 2022 was driven by strong operating performance with quarterly earnings in the first two quarters of 2022 exceeding $2 per share in each of the three-month periods!

As earnings fell to just $0.43 per share in the third quarter, hurt by plant turnarounds, AdvanSix did not guide for an earnings recovery in the fourth quarter of 2022, as I exactly feared this cyclicality, although fourth quarter earnings did eventually come in at $1.27 per share.

This made that full year sales rose to $1.95 billion on which $309 million in EBITDA and $172 million in net earnings were reported, with net debt down to just $85 million. Trading at $43 in February, the 28 million shares were valued at $1.2 billion. The issue for 2023 is that capital spending was seen rising to $110-$120 million, exceeding depreciation charges by $40-$50 million (based on the expense in 2022), creating a real headwind on cash flows in a more uncertain environment, making me quite cautious.

Valuation Reset

Over the past three months, shares have moved lower, from $43 to $34, with shares down 20% in the time frame of just a quarter. In the meantime, little has happened other than general economic uncertainty weighing on some parts of the market.

Early in May, AdvanSix posted its first quarter results. Sales were down 16% to $401 million, driven by a 9% decline in volumes and associated decline in prices. On top of the decline in sales, EBITDA margins fell more than 5 points to 16% and change, with adjusted EBITDA down to $65 million. Net earnings of $35 million came in at $1.22 per share, with adjusted earnings eight cents higher, quite stable and quite comforting.

Net debt rose to more than hundred million dollars on the back of poor working capital conversion. The company did not provide a full year outlook, but it did re-confirm the capital spending guidance for the year, while seeing a turnaround profit impact being substantially less than 2022, mostly set to occur in the third quarter.

A few days later, AdvanSix reached a union deal for its Hopewell site. This covers 340 workers, under a five-year contract on which few details have been announced. The earnings report revealed that the company started buying back shares again in the higher-thirties, shrinking the share count alongside the business this year to limit the pain on a per-share basis.

With AdvanSix Inc. shares down so much and earnings power trending close to $4-$5 per share, I am gradually warming up a bit to AdvanSix as well. I am fancying initiating a small AdvanSix Inc. position in the lower thirties here as a cyclical play, while fully recognizing that the set-up is not too great for long-term value creation, despite the lower earnings multiples at which shares trade.

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