ARKAF - Arkema: Again A Buy

Summary

• EU gas prices are down significantly and this should support chemical players such as Arkema.
• Return-accretive M&A, strong pricing power, and a solid balance sheet make the company a buy.
• Also, Arkema confirmed its 2022 guidance and its strategic plan for 2024. We believe that the company is not fairly valued on an EV/EBITDA multiple versus its historical average.

Following our recent publication on BASF in which we provided a top-down analysis into the EU chemical companies, today we are looking back at Arkema ( ARKAF ) ( ARKAY ). In our company's history rating change, when we initiated coverage on the French chemical company with a buy and a deep-dive analysis called An Unwarranted Discount To Peers , Arkema delivered a plus 80% in stock price appreciation (including the dividend payment). Later on, we decided to decrease our target price to €100 per share and lower our rating to neutral; and so far, it was a good call - you can check out our previous publication Arkema: We Hold For Now .

There are several considerations from the BASF follow-up note which are worth reporting:

• Firstly, European Union gas prices are finally back at a pre-war levels; despite that, as already mentioned, EU gas prices are still above the world average costs and here at the Lab, we are more concerned about the FY 2023-2024 period. Thanks to the 2022 warmer winter, EU gas inventories are still at 90% capacity and we are not forecasting any lower production volumes over the next six months;
• Secondly, the profitability of EU chemical companies is rather weak; however, Arkema is not involved in soda ash production and is partially dedicated to ethylene output, two items that we foresee will negatively impact margins. On the negative side, we should say Arkema's acrylic acid and polyvinylidene fluoride (PVDF) will probably suffer from additional capacity expansions. In detail, acrylic spreads already declined by more than 20% from the May 2022 peak and are still ~1/3 higher than their mid-cycle levels. For this reason, Arkema might suffer slightly in profitability into 2023.

Last time, we concluded that Arkema's downside risks were equally important and we highlighted our negative key points.

Today, on a standalone basis, we believe that the following items will be the key positive takeaways to monitor:

1. Earnings defensiveness and a solid balance sheet are two topics to closely watch and we believe that Arkema is well positioned in this regard. Including hybrid bonds, the company's net debt on EBITDA is at 1.2x and despite a bolt-on acquisition, Arkema's debt is still within the management target. Average maturity is higher than 4 years and the company has a stable investment grade rating at BBB+ and Baa1 respectively from S&P and Moody’s (Fig 1);
2. Similar to BASF, almost 65% of the company's total sales are not in Europe (Fig 2);
3. Having checked the company's latest quarter, Arkema was able to fully pass through raw material inflationary pressure. Given the strong track record and despite lower volumes, we are confident that Arkema's pricing power will remain strong for next year (Fig 3);
4. Still related to point #3 and to support Arkema's future margin is the fact that many chemical players are announcing de-stocking policies and this could support higher selling prices;
5. Arkema maintained its 2022 guidance with positive confirmation for the 2023 and 2024 plans. In detail, the French chemical player announced its EBITDA target of €2.1 billion which represents an annual EBITDA growth of 20% versus 2021 numbers;
6. The company is continuing to pursue its business portfolio management with acquisitions and disinvestments (Fig 4). In addition, the company is clearly targeting the higher demand for renewable energy projects, EV productions, and sustainable lifestyle products;
7. Going to the valuation, Arkema is currently trading at an EV/EBITDA of 4.5x while the company's 10-year historical average is at 6.4x. Cross-checking Wall Street analyst expectations, this valuation implied that Arkema should lose almost 1/3 of its total EBITDA and we believe that is unrealistic. For this reason, applying our rule on cyclical stocks (buy them at a long-time low and sell them when the economic picture is far better), we decided to increase our valuation back to overweight. Based on the 2.15 billion EBITDA projection for 2023, considering debt-like obligations, and applying the company's historical multiple, we derive a valuation of €110 per share versus the current €89 per share.

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