CSTM - Constellium Is Capable Of Casting Growth Drivers Into Upside Potential

Summary

• Constellium is coping well with the energy crisis and inflationary pressures thanks to the pricing power that comes from its strong position in the strategic verticals.
• Secular tailwinds should encourage demand for company’s downstream specialty aluminum products going forward.
• CSTM’s stock is currently trading at an attractive valuation with a worth noting discount and prominent upside potential.

Constellium ( CSTM ) is favorably allocated and positioned in its business verticals, which is a result of the company's main focus on cyclically-resistant packaging end-market and strong customer base. I believe that sustainability-driven secular tailwinds in the CSTM's key markets will ensure strong demand for the company's downstream products. Additionally, the company’s ability to overcome inflationary pressure through cost control and pricing power, along with de-leveraging of its balance sheet will provide for sustainable cash flow creation potential. In this article I will try to pass my bullish call on CSTM by going through its key markets, strong financial results and attractive valuation.

Company overview

In my previous article , I took a closer look on the reasons for suppressed competitiveness of European industrial manufacturers. Since the beginning of the year, some companies in energy-intensive industries have reduced or completely closed down their production operations due to elevated input costs in order to stay afloat. Against this backdrop, Constellium is navigating well in this complex inflationary environment. CSTM is a global leading aluminum downstream manufacturer, focused primarily on packaging, automotive and aerospace end-markets. The company is engaged in production of a wide range of rolled and extruded products and operates through Packaging and Automotive Rolled Products (P&ARP), Aerospace and Transportation (A&T) and Automotive Structures and Industry (AS&I) segments.

Packaging

Packaging end-market is at the forefront of the company’s operations as it accounted for around 40% of the total sales in 9mo 2022. The packaging market is characterized to be stable and recession-resilient, which along with sustainable packaging trends gives the company's business model reasonable assurance of continued profitability even in turbulent times.

Sustainable (or green) packaging strives to minimize the use of energy and reduce the negative impact on environment. The key driving factors for the green packaging will be strict government environmental legislation and increasing awareness of environmental issues. Regarding the latter, the leading FMCG (Fast-Moving Consumer Goods) companies have committed to the sustainability clause with main focus on recyclability of used materials and reduction in the overall use of plastic.

Even though the world is gradually shifting to renewable sources, most of our energy still comes from fossil fuel. The more energy is saved in the production of new materials and their subsequent recycling, the less GHG emissions will be released. Recycling aluminum requires just 5% of energy needed to produce the primary aluminum, which combined with the metal's endless recycling feature makes it an appealing option for sustainable packaging.

Among the key customers of the Constellium’s beverage cans and foil products are Crown Holdings ( CCK ), Ball Corporation ( BALL ) and Coca-Cola ( KO ), which command the leading positions in the packaging industry and will provide for strong demand of CSTM products amid the secular shift from plastic to aluminum.

Automotive

The automotive industry is affected by combination of global headwinds, including energy crisis, ongoing supply-chain disruptions, geopolitical tensions and demand slowdown. This led to a decline in new car production in Europe to 9.7 million units, down by 2.4% in the first 9mo into 2022, mainly due to the military actions, which impacted the overall production in the region. In the same time, North American production output increased by 11.8% over the same period on strong demand for new vehicles in the US (5.3 million units; +12.1%).

The demand of aluminum used in car parts is rising exponentially, owing to the lightweight megatrend aimed to increase the vehicles fuel efficiency. Additionally, the displacement of fossil fuels opens a bright spot for the development of electric vehicles market.

So far in 2022, approximately 14% and 6% of all new cars registered in European and US market, respectively are battery electric vehicles (BEVs). The share of BEVs is expected to reach 70% of the European market by 2030, leading against other world regions, which is not surprised given Europe’s green ambitions rush.

The above delineated electrification trend will be favorable for aluminum demand, as on average an EV has higher aluminum content than a traditional ICE vehicle. Currently, one of the key challenges for EV’s is to achieve a range capability similar to that of ICE vehicles. The latter can go over 400 miles, whereas e-cars struggles to surpass even 300 miles due to being relatively heavier. The increased use of aluminum in e-cars bodywork and platform will be essential to bring their weight figure down.

Constellium provides auto body sheet and structural products for leading global car manufacturers, including Mercedes-Benz ( MBGAF ), BMW ( BMWYY ) and VW Group (VWAGY) based on multi-year agreements. With the gradual transition to an electrified future of the industry, I believe the opportunities for the above listed OEMs will abound, which will ensure strong demand for CSTM’s automotive rolled and extruded products.

Aerospace

The global health pandemic brought sudden passenger air traffic halt and left major aircraft OEMs suffering from lower order intake, backlogs erosion and reduced production. Airbus ( EADSF ) and Boeing ( BA ) are among the key customers of Constellium, where the company provides the aircraft OEMs with extrusions, plates, sheets and wing skins.

Over the first nine-month of 2022, Airbus and Boeing delivered a combine 766 commercial aircrafts, which was 23% on top of the same period in 2021. Despite recovery in passenger traffic and build rates, the two major OEMs have a long way to go to bring deliveries back to the last “normal” year before pandemic, where both companies delivered around 1 600 fleets.

The rapidly growing application of composite materials in the aerospace industry for lightweight reasons should keep demand for aluminum alloys solid going forward. In its latest forecast, Airbus expects global annual passenger traffic to grow at a 3.6% CAGR over the next 20 years. Additionally, replacing an aging fleets with new-generation fuel-efficient aircrafts will further increase demand for aluminum rolled and extruded solutions applicable in aerospace. This combined with production rate recovery, will support the Constellium’s highest margin segment sales.

Financials

CSTM reported 27.4% YoY growth in total sales to EUR 2.02 billion for the third quarter of 2022. The growth was driven by improved product mix, favorable pricing and higher aluminum prices despite lower overall shipments (387 thousand mt) by 2% compared to the relevant quarter of last year. Q3 Adjusted EBITDA of EUR 160 million increased by 11.9% YoY due to the strong results of P&ARP segment (+15.4% YoY), underpinned by mid-double-digit growth in A&T (49.5% YoY) and AS&I (+ 45.1% YoY) segments.

For the 9mo period, total revenue was up 41.2% YoY to EUR 6.27 billion. Adjusted EBITDA marked 21% YoY increase due to resilient performance across all segments, despite operating challenges at the company’s main facility Muscle Shoals. Thanks to the prudent cost control, the company managed to limit the fall in EBITDA margin to 8.4% (-140 bp). As a result, Constellium recorded a net profit of EUR 1.86 per share, compared to EUR 1.69 per share in the respective period last year.

The management expects Adjusted EBITDA to be in the range of EUR 670-690 million and Free Cash Flow to exceed EUR 170 million in 2022. Despite reduction in the leverage ratio to 3.0x, the company intends to push the ration further down to the long-term target range of 1.5x-2.0x.

Valuation

I approached the valuation of Constellium using peer selection. The following table presents my expectation regarding the company’s Total Sales and EBITDA for the Q4 and 2022 full year.

For 2022, I assumed 38.4% sales growth on the back of strong Packaging and Automotive rolled products demand, and positive developments in Aerospace, as major aircraft OEMs announced build rate expansion. The industry end-market will also contribute to the financial performance due to resilient demand for the extrusions products by Rail and Solar sectors. With the above assumptions, I estimated CSTM’s full-year revenue to reach $8.5 billion with EBITDA of EUR 695 million on a margin of 8.2%.

I selected Arconic ( ARNC ), Kaiser Aluminum ( KALU ), Norsk Hydro ( NHYDY ) and Century Aluminum ( CENX ) as a peer group in order to derive the sector EV/EBITDA forward trading multiple.

CSTM is trading currently at EV/EBITDA forward multiple of 5.2x, which represent a significant discount of around 30% to the sector’s median of 7.4x, derived from the main comps. Applying my estimate of EBITDA to the peers median multiple should yield enterprise value of EUR 5.1 bullion. Net of interest-bearing liabilities, the implied equity value should be EUR 2.8 billion, which corresponds to EUR 19.70 per share and implies 62% upside potential. I believe this valuation will reflect Constellium’s: pricing power; gradual de-leveraging objectives; management’s strong focus on cost control to mitigate inflationary-induced input costs pressure; favorable position in resilient and secular growth driven end-markets.

Risk factors

Operational challenges are a major constraint to the company’s financial results, especially at core production facilities (such as Muscle Shoals), which are primarily focused on servicing the packaging end-market. Additionally, ongoing high inflationary environment and rising interest rates could significantly impact consumer confidence, thus limiting the performance of the automotive end-market. Overall, stagnation in strategic verticals due to ongoing recession fears could compromise CSTM’s profitability.

Conclusion

Constellium feels relatively comfortable amid the ongoing energy crisis and inflationary pressure on operating costs. However, these short-term headwinds are offset by secular growth drivers in packaging, automotive and aerospace due to the lightweighting megatrend, growing demand for BEVs and sustainable shift to aluminum as a result of its high recyclability. In addition, management’s focus on cost control and commitment to further balance sheet strengthening by decreasing leverage position should improve FCF generating ability and unlock sufficient cost savings to achieve and maintain the company’s long-term Adjusted EBITDA target of over EUR 800 million. Coupled with a strong customer base among strategic vertical, the demand for Constellium’s specialty aluminum products should increase going forward. I believe CSTM is an attractive investment opportunity, and current prominent discount to the main comps could turn very lucrative to long-term investors.

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