ASIX - AdvanSix: No Longer Advancing

Summary

• Shares of AdvanSix have seen a painful reversal in recent months.
• This comes despite very strong operating momentum.
• I like this combination, even as a substantial negative earnings revision seems in the works, appearing to be only a matter of time.

In the spring I noted that AdvanSix ( ASIX ) was advancing along after a very strong 2021, driven by a combination of higher volumes, pass-through pricing and market pricing. The increase in earnings power and elimination of debt overhang created a compelling situation, as the company guided for a very strong 2022, ahead of the Ukraine war.

Some Background

AdvanSix was spun off from its former parent Honeywell ( HON ) all the way back in 2016. The company produces ammonium sulfates, nylon and chemical intermediates, typically seen as commodity products with associated pricing, although that some of the volatile component is hedged by strong correlation between input and energy prices. That is a bit too simplistic as input prices are largely tied to energy prices, while demand implications impact market pricing for the products as well.

At the time of the spin-off, AdvanSix was posting sales of around $1.5 billion on which it posted EBITDA of $200 million and net earnings around half that number, equal to $3 per share, with shares trading around the $40 mark at the time.

Poor cash flow conversion, the result of the need to upgrade facilities, and historically strong margins raised some questions as a 13 times earnings multiple optically looked compelling. Shares fell to the teens in early 2020, even ahead of the pandemic, as sales, earnings and cash flows were lagging, and with all metrics under pressure, relative leverage ratios were on the increase as well. Years of stagnation and increased focus on ESG made that I believed that the company was facing an uphill battle, which prevented me from taking a position.

The $10 stock around the time of the pandemic rallied to $47 in spring 2022 as the company has seen incredible operating performance in 2021. Full year sales rose to $1.68 billion on which EBITDA of $255 million and earnings of $140 million were reported, for earnings of $4.81 per share. It must be said that earnings power only totaled $0.80 per share in the last quarter of the year.

With earnings power trending between $3 and $5 per share, and net debt down to just $120 million, the future arguably looks a lot better. Debt reduction is driven by strong earnings power and the fact that the largest investment cycle to upgrade facilities seems to be a thing of the past by now with capital spending seen around a hundred million a year now. The strong performance even triggered the company into announcing a $100 million deal for US Amines.

The question is how things would evolve in 2022. The war triggered great demand for ammonium sulfate with food supply threatened, yet higher energy prices would hurt the business as well. Being furthermore mindful of softer operating momentum, and judging 2021 earnings to be historically strong, I was not happy to join the ride at $47 in March, even as the outlook was still pretty decent.

A Pullback

After a brief run higher to $57 in the same month of March, shares are now back to $33 as the market and investors have feared and picked up the cyclical element of the business, as a net $14 drop from March marks for a serious pullback.

First quarter sales rose 27%, entirely driven by pricing with volumes down 4%. The company posted a strong $103 million EBITDA number on $479 million in sales, as net earnings of $63 million came in at $2.15 per share.

Second quarter sales growth accelerated to 33% as revenues came in at $584 million with GAAP earnings advancing further to $2.23 per share, as earnings still trend at a very impressive $8-$9 per share! Net debt fell further to $130 million despite the US Amine deal, with net debt just surpassing the quarterly EBITDA being generated.

Despite the strong earnings power, shares have fallen, essentially trading at just 4 times earnings here. This makes it pretty clear that investors fear that momentum cannot be maintained. So here we see shares down meaningfully, with net debt own, and earnings in the first half being far stronger than anticipated.

With the current enterprise value having fallen to the billion mark, it is very clear that expectations are low, as leverage is far from a concern and current earnings power is still solid, something which can reverse anytime soon now. This comes as economies are suffering from high energy prices and monetary tightening measures being taken by central banks across the world.

And Now?

Right now I feel much more comfortable to buy AdvanSix as I did in March, even though it is much more clear that some earnings reversal will take place. Fortunately, the company will not likely face financial hardship given the strong balance sheet, and while earnings power could be hurt for a while, the risk-reward is appealing enough to slowly start initiating a modest position.

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