DD - Celanese Corporation: A Sign Of Relief

2023-12-27 17:43:39 ET

Summary

• Celanese Corporation's acquisition of DuPont's Materials & Mobility business raised leverage and skepticism, leading to a decline in share prices.
• While 2022 earnings have held up relatively well, the real pain has been seen in 2023.
• I am cautious about Celanese Corporation given the leverage employed and recent momentum seen in the share price.

In February 2022, I offered some thoughts on shares of Celanese Corporation ( CE ) post the deal with DuPont de Nemours, Inc. ( DD ) . The company started the year 2022 with a big deal, as it announced the acquisition of DuPont's Materials & Mobility business in a large and relative expensive deal.

The deal raised the leverage profile and some eyebrows given its timing, all of which made me cautious. As it turned out, a higher inflationary and interest rate environment pushed shares below the $100 mark later in 2022, and even after a spectacular recovery in recent weeks, shares are trading flat over the past two years. This is for good reasons, as peak profits have come down, pushing up leverage ratios, with no quick avail in sight.

A Recap

Celanese is a large global chemical and specialty materials business. For the year 2021, the company generated $8.5 billion in sales from three major product categories. The largest of these was a $5.4 billion acetyl chain business, a diversified business which posted very large segment profit of $1.8 billion, generated from a wide variety of industries, with strong margins driven by strong economic conditions seen in 2021.

The engineered materials business generated $2.7 billion in sales that year, while posting operating profits of $400 million and change, complemented by a small acetate tow business which contributed minimally to earnings.

Overall, EBITDA was reported at $2.8 billion, marking a spectacular improvement from the 2020 results amidst a recovery in the core business and the impact of some smaller M&A efforts. Earnings came in around $17 per share for the year, with net debt of $3.4 billion translating into a modest leverage ratio.

With 112 million shares trading at $156, the company was awarded a $17.5 billion equity valuation, or $21 billion enterprise valuation. Trading at just 2.5 times sales and 8-9 times earnings, this looked like a non-demanding valuation, but the 2021 resulting were very strong and likely not replicable (at least not based on average margins through the cycle).

This was certainly the case as the company was battling with huge cost price inflation amidst higher energy prices (even ahead of the war between Ukraine and Russia) which would likely cast pressure on 2022 earnings.

Amidst this background, Celanese announced a big $11 billion cash deal to acquire DuPont’s Mobility & Materials business, while the own business was valued at $21 billion. The acquired activities produce engineered thermoplastics and elastomers, used in automotive, electrical, electronics and industrial applications. With a $3.8 billion sales and $900 million EBITDA contribution, the valuation was a bit more demanding at nearly 3 times sales and 12 times EBITDA, although that Celanese claimed $450 million in synergies by 2026.

Shares of Celanese overnight fell some 5% to $144 per share, shedding a billion in shareholder value in response to the deal, driven by the higher upfront multiple paid, and likely skepticism on the expected sizeable synergies. Moreover, there were concerns on ((PFAS)) liabilities, as DuPont has similar liabilities as well, with the deal terms not being very forthcoming on these.

Pro forma net debt of $14.4 billion translated into a 3.9 times leverage ratio based on pro forma EBITDA of $3.7 billion, all of which made me a bit cautious even as the deal would immediately boost earnings by some two dollars per share. Even with earnings power seen around $20 per share, while shares traded in the $140s, I failed to get too upbeat on Celanese.

Bust And Boom

A $140 stock in February 2022 ended up falling below the $100 mark by October of last year, as investors feared weaker economic conditions on the business, driven by inflationary pressures induced by higher energy prices. Shares mostly traded around the $100 mark this year and traded around $110 as recent as October, before seeing a huge run higher to $157 per share at the moment of writing.

On the first day of November 2022, Celanese closed on the purchase of Mobility & Materials. In February of this year, the company posted its 2022 results, which included the contribution of the acquired activities for about two months in time.

Aided by this deal, Celanese grew 2022 sales from $8.5 billion to nearly $9.7 billion as operating profits fell from less than $2 billion to nearly $1.4 billion as strong market conditions turned. The company posted GAAP earnings of $17.34 per share on a diluted basis, slightly higher than 2021, which was a positive surprise. This was driven by a some one-time items, with adjusted earnings down from $18.12 per share in 2021 to $15.88 per share in 2022, still a bit better than expected at the outset of the year.

Net debt was posted at $13.2 billion, down a bit from the numbers posted at the time of the deal announcement. This was badly needed as the company has seen tougher times, as the company guided for a mere $1.50-$1.75 adjusted earnings per share number for the first quarter of 2023, inclusive of a $0.30 per share amortization charge. The only positive on this very soft outlook was that sequential improvements were seen during the year.

2023 - Modest Advancement

In May, Celanese posted a 12% increase in first quarter sales to $2.85 billion, with adjusted earnings reported at a mere $2.01 per share on the back of a $596 million operating EBITDA number. Fortunately, the company guided for further improvements, seeing second quarter earnings around $2.50 per share.

In June, the company announced the signing of the Food Ingredients business into the joint venture Nutrinova, a venture in which it collaborates with Mitsui. This partner will pay $472 million to acquire a 70% stake in the business which generates about $170 million in annual sales, being valued at 15 times EBITDA.

In August, second quarter sales were reported at $2.80 billion with adjusted earnings of $2.17 per share missing the guidance, with EBITDA seen at $616 million. No immediate improvement was seen, with third quarter adjusted earnings seen between $2.00 and $2.50 per share. This suggests a $6.18-$6.68 per share number for the first three quarters of the year, as a $9.00-$10.00 per share outlook for the year suggested that the year would end on a high note.

Coming Alive

In November, Celanese reported third quarter sales of $2.72 billion, down a bit on a sequential basis with pricing under pressure. Despite the softer sales trends, the company did squeeze out a relatively strong $2.50 adjusted earnings per share number. That is about the good news, as fourth quarter earnings are seen stuck around $2.10-$2.50 per share, meaning that earnings are seen at the lower end of the original $9-$10 full year earnings per share guidance.

The promising news, despite the softer earnings, is that net debt has come down further to $12.3 billion, badly needed as EBITDA trends around $2.5 billion here. This works down to a 5 times leverage ratio, as this leverage overhang, in combination with a reversal of earnings, have been the reasons for pressure seen on the shares. This also manifests itself into a current $700 million interest expense.

It has been the lower interest rate environment, which has come down by over a point in recent weeks, which will have the potential to boost earnings by over a dollar per share in the medium term.

And Now?

By now, Celanese Corporation shares have recovered to a market multiple based on the current earnings power, which has been cut in half since early in 2022. At the time, it already felt obvious that such earnings power was not sustainable.

The issue is that this lower earnings power jacked up leverage ratios, even as net debt has been cut a bit, with leverage now reported at 5 times. Most of the worst concerns are a thing of the past given the aggressive move lower in interest rate and the fact that some refinancing has taken place, resulting in extended maturities.

Moreover, some key commodity prices have recovered as well, boding well for the top line, although the real impact remains to be seen in 2024. While it is understandable why Celanese Corporation shares have recovered, those shares have seen a 40% recovery in recent weeks. This marks a huge recovery, yet shares are basically trading at par compared to early 2022, some two years later as the deal turned out to be too expensive and ill-timed, as I feared.

Given all this, I remain cautious here, taking into account the fundamental performance, and certainly the recent share price performance in recent times.

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