OCINF - OCI: Supportive Backdrop And A Discounted Valuation

2023-10-24 11:31:48 ET

Summary

• OCI N.V. is a leading Dutch fertilizer company facing an attractive backdrop in the nitrogen and methanol business.
• The company is well-positioned to benefit from the green transition and the emerging hydrogen economy.
• The investment case for OCI is supported by attractive valuation, strong free cash flow generation, and potential for higher capital returns.

We present our note on OCI N.V. ( OCINF ), a leading Dutch fertilizer company with a Buy rating. We are drawn by the strong tailwinds of the nitrogen and methanol business, exposure to green trends, significant free cash flow generation, and a valuation discount. We will provide a brief description of the business, introduce key thesis points and risks, lay out our investment case, and value OCI’s equity.

Introduction to OCI

OCI is a top global player in nitrogen and methanol products. The group has an unrivaled global footprint which provides an embedded competitive advantage. OCI is an integrated fertilizer and chemicals producer and benefits from cost advantages in most of its production areas. Assets are located primarily in Africa, the Middle East, and the US. The company has 12 million tons of nitrogen fertilizer production capacity, 7 million tons of gross ammonia capacity, and 3 million tons of methanol capacity. Moreover, it has the largest seaborne merchant ammonia and urea platform globally. The billionaire Sawiris family owns ~53% of the outstanding shares, while the rest is free-floating. The company is listed on the Euronext Amsterdam and has a current market capitalization of €5.2 billion.

Robust nitrogen and methanol outlook

After a perfect storm (caused by gas prices, weather events, etc.) that negatively affected pricing this year – bottoming in Q2, we believe OCI is set to benefit from the upswing in the nitrogen and methanol markets, despite production outages in this quarter. We forecast continued robust demand for nitrogen supported by higher crop prices. Nitrogen-intensive crops such as wheat are favorably priced, leading to higher fertilizer affordability, more farmer profitability, and an overall positive momentum for fertilizer producers. Pricing should be supported by low inventories, and a constrained supply in the midterm i.e., 2023-2027. In addition, as gas prices reach more moderate levels, margins should also improve from current levels.

Moreover, methanol prices are also improving on the back of macroeconomic conditions, higher oil prices, and increased affordability, providing additional upside for OCI. We have a constructive outlook both on price recovery as well as volume growth supported by demand and OCI’s new capacity additions.

OCI in the Green Economy

OCI is in a strong position to benefit from the green transition and the emerging hydrogen economy. The company is a top player in ammonia and methanol , which are key to global net-zero goals. Multiple clean methanol and ammonia initiatives are ongoing, and OCI has a detailed strategy regarding its assets. Ammonia could shape the hydrogen value chain as a “hydrogen carrier” conducting the transportation of clean hydrogen from “hinterland” producers in the Middle East and Africa to importers such as East Asia and Europe. In September, OCI signed an agreement to offtake green hydrogen from New Fortress Energy beginning in 2025, significantly scaling up green ammonia production capacity to ~ 160k tons per year in Beaumont, Texas.

Moreover, clean methanol is being established as the green fuel of the shipping industry with OCI fueling the first-ever green methanol-powered ship, in a partnership with Maersk. The methanol marine orderbook is expanding significantly, and incremental methanol demand from marine fuels is expected to reach 6Mt by 2027-2028. We expect the green transition to be a major drive of value creation for OCI going forward.

Investment case, valuation, and capital returns

As highlighted above, our case on OCI relies on an attractive structural outlook for fertilizers and methanol, positioning in the green fuels space, and strong FCF generation and subsequent deleveraging. We value OCI using EV/EBITDA multiples and free cash flow yields. Broadly in line with sell-side analyst consensus, for FY2024e we forecast sales of €6.1 billion (~10% growth YoY based on our price and volume assumptions) and an EBITDA of €2.1 billion which reflects a significant margin improvement due to operating leverage and the change in gas prices. We then forecast €405 million of net income, €1.5 billion of CFFO, and nearly €690 million of free cash flow in FY2024e. As capex subsides to around €300 million per annum post-2024, and net working capital normalizes, we expect FCF to be closer to €1 billion by FY2025 and onwards, leading to a rapid deleveraging of the balance sheet, and higher capital returns to shareholders. With an enterprise value of ~€8 billion, our forecast implies a forward EV/EBITDA of just 4x, significantly lower than the 5-year average of ~7x; a forward FCF yield of ~9%, and an FCF2025e yield of more than 13%. We believe these implied multiples are quite punitive and do not reflect the strength of OCI. We conservatively value OCI at a forward EV/EBITDA ratio of 5x (also taking into account normalized numbers) implying an equity value of €7.1 billion and a share price of €31.3 or 34% upside. Alternatively, we value OCI using a normalized FCF2025e and discounting to the present. We forecast a normalized FCF of €1 billion, estimate a cost of capital of 10% and a 2% growth rate, hence arriving at an enterprise value of €12.5 billion in FY2025e, discounted to €11.3 billion in the present, arriving at an equity value of €8.4 billion or €36.90 per share i.e., 58% upside.

Regardless of valuation methodologies, we estimate that the current share price represents an attractive entry point, and we recommend buying OCI shares. While there is no imminent catalyst, the robust nitrogen market, execution in methanol and hydrogen, deleveraging, and capital returns should unlock OCI’s value.

Risks

Downside risks include but are not limited to weakness in the underlying agricultural markets and lower crop prices, increased supply from new capacity additions given the low barriers to entry, lower nitrogen, ammonia, and methanol prices, lower utilization rates, higher natural gas prices, political instability given the geographic footprint of the business, and unfavorable weather events.

Conclusion

Given the meaningful valuation discount combined with a robust outlook, we recommend buying OCI shares. OCI is one of our top picks in the chemicals sector.

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