LNXSF - Lanxess: Lacks Staying Power
2023-09-13 15:55:18 ET
Summary
- LANXESS has to close plants as energy inflation and CO2 measures pose a secular problem.
- European and Chinese construction is weak. Electronics aren't great either. This poses major problems for the company, especially a questionable China.
- The issue of Chinese recovery is not a given, so LANXESS is beyond our risk appetite despite the substantial price hits.
LANXESS AG ( LNXSF ) is pretty exposed to China, whose economy is in turn exposed heavily to the construction industry which dominates the plurality of their GDP. We think China will not repeat the comebacks of past economic and debt scares since China's economy turns on the goodwill of other nations and the trends of globalisation. While we don't think China is immediately doomed at all, we think that China will underperform in its rebound and that the Chinese government doesn't have too much agency in improving the economy. With new construction markets definitely slowing down, something we've seen across our coverage, and with it being exceptionally bad and maybe secularly bad in China, LANXESS remains quite dangerous since it has a lot of construction exposure. Electronics is bad too. Exactly the markets we worried about last time are beginning to really concern management as well, and deflationary trends are now beginning to appear above just the most basic of commodities. While some recovery can be expected in some of the geographies for construction, like in the US due to demographics, LANXESS is pretty risky and volatile, and we think there are important outstanding questions that need to be answered before it can be considered for investment.
Q2 Breakdown
What was pretty noticeable is the fact that the company is closing down some plants. While these plants are currently not EBITDA contributors, and they probably won't recover much as otherwise LANXESS would hang onto them, they are pretty big sales contributors and represent meaningful volumes. The Hexane Oxidation plant that they are closing accounts for a little less than 20% of sales based on management comments:
Yes, Konstantin. Let me address them one by one. [indiscernible] oxidation it's close to €100 million sales, and there is no EBITDA.
There are other closures going on. While destocking and weak demand are problems, the issue is on the cost side. These are energy intensive and the cost of CO2 through the CO2 licenses are going up secularly to address CO2 emissions. These are not attractive assets going forward, and they're closing down. They have no EBITDA contribution, so there will be run-rate improvements in EBITDA margin as these go off, and some of the cost cutting that comes with it will cumulatively contribute to the overall 150 million EUR cost savings plan. It's not that big savings in the end. The lack of staying power due to structural costs and the energy price situation is a bit of a concerning sign. Even if these sales were thinly profitable, that's gone now and will be gone forever. Money will have to be spent to replace that capacity, even if it is definitely better retired than kept.
Demand is a huge problem for LANXESS, and forecasts had to be revised downward since there were no signs of recovery in major markets.
I mean Europe is soft. China is very concerning. I've never seen construction in my professional life as bad as it is right now. E&E, obviously, all of you have bought whatever mobile devices your children and you need during the pandemic time. But we also see that E&E despite product innovations is hard hit.
Matthias Zachert, CEO
These segments account for more than half of the company's chemical volumes. Europe is understandably soft, but China is a concern and is in its totality about 22% of sales. There are risks of a death spiral in debt write offs and credit conditions. The government can limit this spiral, and it is a mystery why they haven't come in harsher yet (possibly moral hazard concerns?), but China ultimately has been a massive beneficiary of deglobalisation, and that goodwill is basically done for. While China has come back strong in the past, we think this time it's different because of this critical deglobalisation factor. We are not willing to bet on a Chinese recovery.
Bottom Line
Volumes are down as destocking continues and China offers no respite whatsoever, likely to just get worse.
What's interesting even for the rest of our portfolios is that there is some deflation going on. While specialty building products companies are still seeing pricing being supporting, that is decelerating. And with LANXESS we are seeing less specialty exposures start getting hit by deflation, downstream from some even more basic commodities, as industry and levered industries like construction see slowdown.
The problem is we don't see the European or Chinese situation improving. We think there is hope for America to actually produce housing growth sooner, but without the support from Chinese markets LANXESS situation could be slow to rebound. So despite a compelling price which is retracing to historically weak levels, outstanding risks and questions around Chinese construction make this one too risky for us.
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Lanxess: Lacks Staying Power