2023-06-22 11:17:21 ET
Summary
- Celanese, a chemical and specialty materials company, has strong growth catalysts and an attractive valuation, making it a potential buying opportunity.
- The company has seen increased demand in the engineering materials segment due to electric vehicles, medical and pharmaceutical products, 5G, and sustainability.
- Despite high debt levels and potential risks from an upcoming recession, Celanese's strong growth catalysts and attractive valuation make it a buy-rated stock.
Introduction
What makes Celanese ( CE ) interesting are its strong growth catalysts, as well as its attractive valuation. The stock price has already corrected significantly since its all-time high in late 2021. Celanese is an American company specializing in chemical and specialty materials, and high-performance engineered polymers.
Celanese has quite a few growth catalysts, such as the acetic acid expansion at Clear Lake, debottlenecks and capacity expansions. Currently, the engineering materials segment also offers growth opportunities due to increased demand for electric vehicles, medical and pharmaceutical products, 5G and sustainability. Therefore, Celanese has significantly increased its capacity to meet growing demand. The expansion has led to a dramatic rise in debt levels. The 7.5x debt to EBITDA ratio concerns me greatly. Yet this need not be a problem if profits do not continue to decline. Clear Lake's expansion is expected to add $100 million annually to profits starting in 2024. Therefore, I see no reason to panic; Celanese therefore offers a buying opportunity.
One of Celanese’s many shareholders is Warren Buffett's Berkshire Hathaway ( BRK.A )( BRK.B ), which first bought the stock in the first quarter of 2022 . Its position was increased until the fourth quarter of 2022, after which it was reduced by 9%. Currently, Berkshire owns about $1 billion worth of Celanese company shares, giving it such a significant stake of more than 8%. So, there is clearly a lot of confidence in the company. Yet the share price has fallen considerably since its initial purchase. The share price at the beginning of 2022 was about $170, so the share price is down 36%.
Warren Buffett has not explained why he invests in Celanese; he almost never does for his stocks. What is further interesting is that Markel ( MKL ) has also taken a stake in Celanese. Markel is often called the "baby Berkshire" because of the capital strategy similar to Berkshire Hathaway’s. Both Tom Gayner (CEO of Markel) and Warren Buffett are renowned investors who have grown their insurance portfolios solidly over the years.
So, let's talk about its earnings and growth prospects first and then its dividends and valuation.
Strong Growth Catalysts Come With Risks
Celanese earlier in May reported its results for the first quarter of 2023 with overall strong revenue growth but lagging earnings.
The acetic chain segment is Celanese's most profitable segment with an EBIT margin of 25% compared to 13% for the engineering materials segment. Celanese expanded its acetic acid production in Clear Lake which significantly increased revenues. Revenues in this segment increased 10% sequentially due to strong volume growth partially offset by lower prices. The acetic chain segment has challenging pricing dynamics due in part to energy price volatility and higher costs. Celanese tactically responded to gain from its geographic supply and demand to still have strong profit margins despite increased raw material prices. With an adjusted EBIT margin of 25%, it was up from 21% in the fourth quarter of 2022.
The outlook for the acetic acid chain business segment is positive because of the completion of the new acetic acid production plant in Clear Lake, which will increase profits by another ± $100 million from 2024. I see this as a strong catalyst.
Revenues from the engineering materials segment also showed strong growth, increasing 32% sequentially. In addition to the strong sales growth, EBIT also increased substantially with 56% during the same period. Demand for engineering materials increased sequentially with volume growth of 34%, due to the acquisition of M&M and growth in end markets. The demand for engineering materials in the automotive industry is particularly strong. Higher demand for electric vehicles will drive further volume growth. Nevertheless, the dynamic pricing model remains highly competitive. The decrease in raw material and energy costs is beneficial to the profit margin of this segment, but also affects sales prices.
Despite the strong improvement from Q4 2022, I still see challenges. Volumes of engineering materials fell, excluding the M&M acquisition. However, Clear Lake's expansion will help meet the persistently high demand in the acetyl chains market. The sales prices remain uncertain and demand will not yet be strong enough to justify a price increase in the acetyl chain segment. Therefore, for the second quarter, Celanese expects adjusted earnings per share of $2.50 as the price recovery in the acetyl chain becomes apparent.
As a result of lower commodity prices, I anticipate a rise in price spread. In the long term, I see strong growth catalysts such as growth in electric vehicles and also medical systems. Also, the expansion of the acetyl chain provides a strong addition to earnings. One caveat, however, is that a possible recession could throw a spanner in the works. The treasury yield slope has been negative for some time now, which could indicate a possible recession in the coming year. The automotive end market is cyclical, so this risk spills over to Celanese as well. Fortunately, the acetyl chain is less cyclical because of the many end markets in the food industry.
Dividends And Share Repurchases
The recent acquisition has led to large increases in debt, and total debt is now about $14.7 billion. The debt to EBITDA ratio of 7.5x is extremely high in my opinion. Interest coverage is also at a dangerously low level of only 2, while Ben Graham recommends at least 5 in his book Security Analyses. On a positive note, liquidity is more than adequate at $1.5 billion.
About all of free cash flow is spent on dividends and share repurchases. About $300 million is paid out annually as dividends, representing about 17% of free cash flow. This is easy to sustain in the long run. The remainder will be returned as share buybacks which could increase the dividend per share. Due to the decreased share price, the dividend yield is currently 2.5%. I expect the dividend to increase further after the completion of the Clear Lake facilities. I do not expect the substantial dividend increase to occur until after 2024.
Dividends and share repurchases (Annual reports and calculations)
Valuation And Takeaway
Many analysts expect growth in adjusted earnings per share starting in 2024. In 2025, 22 analysts expect adjusted earnings per share of $16, bringing the forward P/E ratio for 2025 to 7x. The forward P/E ratio of companies in the specialty chemical segment is 16x, so Celanese is very attractively valued in the sector. I think investors have punished Celanese too harshly. The company has strong growth catalysts and is significantly increasing its production volumes. Some end markets may be cyclical in nature, but this risk is already well embedded in Celanese's share price. Investors do need to consider an upcoming recession, which could throw a spanner in the works in the auto manufacturing market that directly affects Celanese's results. I also consider the high debt as a major risk. Weighing the risk against the reward, I arrive at a buy rating.
For further details see:
Celanese: Clear Lake Is A Catalyst, Rewards Outweigh Risks