EVKIF - Evonik: We'll Just Keep On Waiting

Summary

• Lower financial obligations thanks to the favorable pension discount rate.
• Performance Materials exit is sensible to Evonik's sum-of-the-part valuation.
• The dividend was confirmed, and so was our valuation.

After having commented on BASF's FY results , today the other German chemical player Evonik released its 2022 annual update ( OTCPK:EVKIF ; EVKIY ). Here at the Lab, in 2022, we analyzed the company twice providing an outperforming rating, and we recommend that our followers check up on our publications so that they are informed of the story up to now:

1. Evonik's initiation of coverage called: Earnings Defensiveness. Our buy recommendation was based on 1) Evonik's net debt position (and lower pension contribution), 2) the Healthcare division upside with an ongoing portfolio re-reshaping, and 3) a compelling valuation with a juicy dividend yield. As a reminder, the company's main shareholder is a foundation called RAG-Stiftung. RAG has an equity stake of 56% as of 30 January 2022 and relied upon Evonik's dividend payment;
2. Q3 results comment with positive confirmation of our Long-Term Thesis .

It was a good call, Evonik's stock price is up by more than 23% (including the dividend payment) and outperformed the main index returns.

Q4 and FY 2022 results

It was a challenging quarter for Evonik. However, before analyzing the Q4 result details, it is important to emphasize how the company is moving on with our key takeaways:

1. First of all, Evonik managed to reach its EBITDA target (at the lower end, but the company reached €2.5 billion);
2. The company's portfolio reshaping is advancing. Performance Materials divestments are on track and sales growth in the innovation field is up by 20% on a yearly comparison. These were supported by nutrition (+20%) and cosmetic solutions (+60%) (Fig 1).
3. Going deeper into the Performance Materials disposal, we note that peers' trading multiples significantly decreased for lower revenue growth and margin pressure. This is mainly due to an unfavorable macroeconomic backdrop and so this could mean a lower exit value. In our sum-of-the-part valuation, we now ascribe €1.7 billion in value applying a 2023 EV/EBITDA multiple of 7.5x (Lanxess exited its materials business for multiple close to the 12x). This reflects the challenges of the upcoming macroeconomic 2023 backdrop and in addition, what is more important to report is the fact that if the deals will go ahead, this may not create profit for the current shareholders if followed by costly M&As (i.e. Air Products' Performance Materials acquisition in 2016) or additional investment in commodities products (Fig 2). This exit is part of the company's strategy to rebalance and improve its portfolio; however, there is a mismatch between previous M&A track records and targets;
4. Last time, we suggested how free cash flow generation was negatively impacted by higher working capital, and we were assuming a reverse trend. During the Q3 analyst call, the CEO confirmed that "further significant NWC improvements are expected already in Q4 to achieve a 30% cash conversion for the full-year results". Despite higher-than-usual inventories built up, the company managed to achieve the strongest-ever quarterly FCF generation at €603 million (Fig 3).

(Fig 1)

(Fig 2)

(Fig 3)

Looking at the financial performance, Evonik delivered a mixed quarter. Following a year of supply chain issues, Q4 chemicals volume continued to decline mainly due to clients destocking from previous high levels. Having checked BASF, European chemical production was 18% lower compared to last year's end quarter, Evonik was able to be more resilient, and despite a negative result and a GEO presence more skewed towards the EU, closed Q4 with a minus 11%.

The company's financial debt stood at €3.25 billion and was lower from the Q3 level thanks to divestment proceeds such as the betaine operations US and TAA derivatives. In addition, pension provisions further declined to €1.35 billion thanks to a further increase in the discount rate (now at 4.1%). To sum up, Evonik's leverage on the net debt/EBITDA reached 1.8x from 2.7x in the 2021 year-end.

Conclusion and Valuation

Regarding the 2023 outlook, Evonik is forecasting top-line sales between €17 and 19 billion with an adjusted EBITDA between €2.1 and 2.4 billion. This guidance is based on a weak H1 and a stronger H2. As already mentioned in BASF, the company is implying a significant tailwind in China and an improving demand in Europe in the second part of the year; however, neither of these is evident at this point . What is important to report is the fact that Evonik is targeting organic growth above 3.5% and an EBITDA margin increase. If we are looking at the past financial performance, the firm revenue growth was just 1.5% in the 2015-2020 period and the EBITDA margin decreased to 15.9% in 2021 from 18.2% in 2015. As a result, earnings growth has been limited and the company has had to acquire new sources of operating cash flow, and as a consequence, returns have been under pressure. The dividend was confirmed (and we are not surprised) and continuing to value Evonik with a 6x EV/EBITDA on 2023 accounts (considering also a €1.7 billion in proceeds from PM exit), we decided to maintain our target price of €23 per share ($12.25 in ADR). On an EV/EBITDA basis, Evonik is trading at 15% compared to its closest peers. Our risks include higher capacity addition from competitors as well as the risk of potential M&A value destruction.

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