CC - Chemours: Volatile Bottom Line Needs Consistency

2023-10-05 21:15:16 ET

Summary

• The Chemours Company's bottom line has been volatile, with a negative result in the last 12 months.
• CC has managed to diversify the revenue streams very well, but there are still some questions about top-line growth going forward.
• CC faces risks from fluctuations in raw material prices and environmental liabilities, and its high leverage ratio is a concern.

Investment Rundown

The materials sector can be notoriously volatile as the demand and supply of course drive the prices, and when you have a company like The Chemours Company ( CC ) the bottom line can be quite volatile. This has been quite visible in the bottom line of CC as the last 12 months have netted a negative result. In 2022 the price environment was very favorable and the company had net incomes of $578 million. The last quarter showed lower volumes and the impact of lower sales in TT and APM’s Advanced Materials portfolio which is suggesting to me that there is an ample amount of risk here right now.

The price may have come in the last couple of months but I still don’t think it exhibits a buy as the risk/reward is unfavorable until there is a clear consistency in the bottom line of the company. I think that CC could be promising in the long run as the necessity of the materials they make is high in the construction and buildings sector. As a result, I am rating CC a hold for now.

Company Segments

CC delivers high-performance chemicals across a global market that encompasses North America, Asia Pacific, Europe, the Middle East, Africa, and Latin America. The company's operations are structured into three key segments: Advanced Performance Materials, Thermal & Specialized Solutions, and Titanium Technologies. These segments cater to diverse industries and markets, offering a wide range of specialized chemical solutions.

The Advanced Performance Materials division boasts a diverse product portfolio, encompassing industrial resins, customized goods, coatings, and membranes tailored to meet the needs of various industries. These industries span across consumer electronics, energy, transportation, and healthcare sectors. The distribution of these products is facilitated through a hybrid approach, combining both direct and indirect channels. These channels include distributors, resellers, and direct sales, ensuring widespread availability and accessibility for customers. Looking at the contribution from this part of the business it has been responsible for a significant part of the total revenues. With the last quarter's results being $378 million.

With the last report, the segment showcased a decline. It was only the thermal & specialized solutions segment that managed to grow on a YoY basis. The lack of growth from the largest revenue-contributing portfolio I think is worrying and has led to the share price decline we have seen the last couple of months.

Markets They Are In

CC is a very well-diversified company that has managed to get exposure to a broad set of niche markets in the construction sector. Given the broad portfolio of products that CC has, I think that it hasn't necessarily been sufficient to mitigate against broader lower demand.

During Q2 2023 for example, the Titanium Technologies segment of the company continued to face challenges stemming from subdued demand in the residential housing, commercial construction, and packaging sectors. The Fed's efforts to combat inflation, coupled with the consequent increase in interest rates, have placed considerable strain on the housing market. Residential construction , in particular, typically thrives under lower interest rates, although the current conditions appear less conducive, despite the resilient performance of homebuilder stocks. I think that with CC it's a case of waiting for interest rates to go down and for demand to resume organically as more capital is readily available. This doesn't make the company bad by any means, just that revenue growth may be slow right now.

Valuation

Looking at the valuation of CC it right now trades at a slight discount based on earnings to the materials sector. Despite trading at a p/e of 7.93, under 13.62 for the sector, I do find there to be other faults with CC that make it still unappealing to buy. For instance, the FCF is set to take a hit going forward as demand seems to be lacking in both of the segments. This makes CC trade at a p/fcf of 19 on an FWD basis, compared to the TTM of 9.86. With some incontinent demand, it brings into question how the dividend raises might look going forward for CC. I lean right now towards the dividend not being raised the same way it did last year, by over 10% YoY. I think a more realistic one is in the low single digits instead, and that doesn't add enough value here I think to buy the stock.

Looking at a company like Sasol Limited ( SSL ) I think it offers a far more appealing valuation compared to CC right now. With a higher dividend yield of 7% a p/e of just 3.7 and an FWD p/fcf of 2.58. The guidance that SSL provided last quarter seems to have disappointed the markets, but I do find the worst to have passed now and in comparison to CC, it offers more immediate upside.

With another peer like Huntsman Corporation (HUN), we can see that CC looks better based on some metrics like p/e for example. HUN boasts a p/e of nearly 30 on an FWD basis, up from the TTM 20, indicating that HUN may not be able to achieve the same type of earnings as in previous years. I think that earnings seem somewhat more consistent with CC and in light of the large premium applicable to HUN, CC looks like the better option of the two. Besides, the dividend yield for both of them is quite similar as well.

Risks

CC manufacturing operations are sensitive to fluctuations in the availability and cost of essential raw materials such as titanium dioxide, fluorspar, and refrigerants. Any significant changes in prices or disruptions in the supply chain for these materials can exert a notable impact on the company's profitability. It's imperative for CC to effectively manage and mitigate these supply chain risks to maintain stable cost and profit margins. With significant price volatility in the markets, I think CC must maintain a lower set of debt. I am concerned that if the company sees a lack of revenue growth it might resort to taking on debt to fund expansion and drive revenue growth that way. This could potentially lead to a higher leverage for the business and would likely lead to the share price falling further.

As a reference, even if the chart above has shown a decline in the debt on a historical basis. But I think that CC still sits in a very leveraged spot, especially when the last 12 months have led to a significant decline in the EBITDA. The net debt/EBITDA ratio is right now at nearly 10x using the TTM numbers. That is extremely leveraged. However, for the sake of clarity, the 2022 results had the company at a ratio of roughly 3 instead. My preferred ratio would be somewhere under and closer to 2 instead to give some sort of margin of safety and diminish the risk levels.

CC may bear responsibility for environmental damage arising from its past or present operations. This could encompass costs associated with environmental cleanup, waste disposal, and legal proceedings related to environmental liabilities. Such remediation expenses can potentially exert a substantial adverse impact on the company's financial health and performance. It's crucial for CC to prudently manage and address these environmental risks to safeguard its financial stability. Should they face prolonged higher interest rates, higher than the market anticipates then I can see the share price correcting more to reflect the negative sentiment around slowing sales.

Final Words

The materials sector is a largely volatile one and this has certainly been felt in the last earnings report. The largest segment of the company fell drastically and the same has been seen in the share price. I think that the risks are still plentiful given the lack of pricing fundamentals and the clear showcase of lower demand. Until there are markable improvements in the volume levels of the company I will rate CC as a hold. With a yield of over 3%, I think that investors are still getting some value that favors a hold rating as opposed to a sell.

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