- Methanex is the largest producer of methanol, with 9.3 mmtpa capacity.
- It currently trades at depressed valuations of 5.8x P/E, inline with chemical peers.
- Natural gas availability and prices are constraining factors for the industry. Methanex appears better positioned than most.
- Investors are encouraged to keep MEOH on the radar and accumulate shares as Geismar 3 nears completion or if shares trade significantly below replacement cost.
Methanex Corporation ( MEOH ) is a global leader in methanol production trading at cheap valuations. While long term supply / demand dynamics are favorable for methanol, there are significant near-term economic downside risks to methanol prices. Investors are encouraged to wait to accumulate shares closer to the completion of the Geismar 3 expansion or if Methanex trades significantly below replacement cost for the operating plants.
Background
Methanex is the world's largest producer of methanol with an alleged 13% market share in the ~90 million ton market (Figure 1). It has 11 methanol plants across 6 sites that can produce 9.3 million tons of methanol per annum (Figure 2). The company is in the midst of a $1.3 billion expansion project to add a third plant at Geismar, Louisiana, that will bring total capacity to 11.1 million tons by 2024.
Note that the production capacity as quoted by the company is misleading as the production of methanol is critically dependent on the availability of natural gas as a feedstock. Currently, Methanex's plants in Waitara Valley NZ, Egypt, and Trinidad are idled due to a lack of natural gas supply. Hence Methanex's current producing capacity is only 6.2 million tpa (MEOH produced 6.5 million tons in 2021).
Figure 2 - MEOH plant capacities (MEOH investor presentation)
Methanol Basics
Methanol is an essential chemical building block for many consumer and industrial products including carpets, paints, fabrics, building materials, and fuels (Figure 3).
Figure 3 - Methanol is a key chemical feedstock (methanol.org)
There is also a growing clean-energy demand for methanol as a low-emission fuel. In particular, methanol is being considered as an alternative to dirty bunker fuel for marine applications (Figure 4).
Figure 4 - Methanol used as clean fuel (MEOH investor presentation)
Methanol Pricing Softened In Last Few Months
Chinese methanol prices rallied sharply in early 2021 to RMB 4000 per ton (~$600 per ton), as global production was idled in 2020 and restarts and ramp ups lagged behind demand (Figure 5). As global production normalized and economic growth slowed, methanol prices in China have also come back to earth, trading recently in the US$350 to $400 per ton range.
Figure 5 - Chinese methanol prices have softened (tradingeconomics.com)
Note, methanol prices vary widely between regions, with some regions such as the US remaining firm while others like China, softening (Figure 6).
Figure 6 - Global methanol prices (methanol.org)
Long Term Supply/Demand Robust
Global demand for methanol is forecast to be robust, with IHS estimating demand to grow at a 3% CAGR or 14 million tons over the next five years. Even with projected capacity additions such as Methanex's Geismar 3, supply is forecasted to be less than demand, leading to favorable pricing tailwinds (Figure 7).
Figure 7 - Methanol supply / demand (MEOH investor presentation)
MEOH Growth Through Geismar 3
As mentioned above, Methanex is in the midst of an expansion program at Geismar, Louisiana, that will add a 3rd plant at a capital cost of $1.3 billion for 1.8 million tpa capacity. About half of the capital has been spent to date and a further $600-700 million needs to be spent over the coming two years before the project reaches commercial production, estimated at the end of 2023 or early 2024. Once operational, G3 will contribute significantly to Methanex's earnings and cashflow. At recent methanol prices of $350 to $400 per ton, G3 can add $200-300 million in free cash flows per annum (Figure 8).
Figure 8 - G3 adds to Methanex's EBITDA and FCF (MEOH investor presentation)
Natural Gas Is Key Constraint
Conventional methanol is produced using either coal or natural gas as feedstock. Brown methanol (created from coal) is predominantly produced in China and is typically higher cost. Methanex produces grey methanol, i.e. methanol created from natural gas, and its facilities are in the first two quartiles in terms of production costs (Figure 9).
Figure 9 - Methanex assets typically lower cost (MEOH investor presentation)
One aspect of the methanol market that analysts don't often mention is the availability of natural gas as a constraint to methanol production. As we mentioned briefly at the beginning of the article, even Methanex has more than 3 mmtpa of production capacity idled in the past 2 years due to a lack of natural gas (Waitara Valley in New Zealand, Egypt, and Trinidad).
I believe this constraining factor will only get worse in the coming quarters. In conventional methanol plants, it typically takes 28 to 31 million btu of natural gas to produce one ton of methanol. With Russia limiting natural gas export to Europe due to the Russia/Ukraine war, we have seen European natural gas prices spike to over $25 per million btu (Figure 10).
Even if natural gas can be sourced (doubtful given the shortage), this level of natural gas price makes methanol production cost prohibitive in Europe (it will cost over $700 in natural gas feedstock alone to produce one ton of methanol).
In this regard, Methanex appears to have an advantage, as it has plants in Canada and the U.S. with access to natural gas supplies. Furthermore, approximately 60% of Methanex's natural gas supply contracts are linked to methanol prices or are hedged. However, Methanex has 1.7 mmtpa production in Chile with natural gas supplies cobbled together from multiple sources that could be subject to disruption, as noted by the company in its annual report:
While we continue to work with gas suppliers in Chile and Argentina to secure sufficient natural gas to sustain our Chile operations, we cannot provide assurance that our contracted suppliers will be able to meet their commitments, that we will be able to secure additional natural gas on commercially acceptable terms, that Argentina will grant future export permits for natural gas to be delivered to Chile or that exploration and development activities in Chile and Argentina will be successful to enable us to operate at capacity or at all.
Financials Are Cyclical
Figure 11 summarizes Methanex's financials over the past 5 years. As with all commodity businesses, when methanol prices are high and/or natural gas supplies are plentiful, MEOH generates significant profits and free cash flow. For example, in 2018, with realized price of $400 per ton methanol, MEOH was able to generate $556 million in net income or $6.92 per share and almost $1 billion in operating cash flows.
Figure 11 - MEOH summary financials (MEOH 2021 annual report)
However, when pricing is low and natural gas feedstock is constrained, MEOH can also lose money, as was the case in 2020.
In the latest quarter, Methanex was able to realize $425 per ton of methanol and delivered $1.60 per share in EPS (Figure 12). Note the company reports adjusted EPS of $2.16 per share, but that figure adjusts for mark-to-market impact of share-based compensation, which is a real cost, and should not be ignored, in my opinion.
Valuation Looks Attractive
In terms of valuation, MEOH looks cheap on an absolute basis, trading at 5.8x 2022 P/E. However, it is not particularly cheap when compared to other chemical companies such as LyondellBasell ( LYB ) or Celanese ( CE ). Figure 13 shows MEOH's valuation relative to peers. Chemical companies are currently trading at depressed valuations as there is an expectation of a global growth slowdown / recession.
In addition to earnings, we can also analyze Methanex's replacement cost. For Geismar 3, Methanex is spending $1.3 billion to add 1.8 million tpa capacity, or $720 million per mmtpa. Scaling to Methanex's total capacity of 9.3 mmtpa, simplistically the replacement cost would be $6.7 billion versus MEOH's enterprise value ("EV") of $4.9 billion. Alternatively, Methanex's EV appears fair value for its' current productive capacity of 6.5 mmtpa ($4.7 billion replacement value), with the idled plants representing a 'free option' that may be valuable at a future date.
Investment Risks Skewed To Downside
Natural Gas Risk
As previously mentioned, the availability and price of natural gas feedstock is a key risk for Methanex. Although Methanex has methanol linked pricing and natural gas hedges for a majority of its natural gas supplies, it remains top of mind for me as a downside risk. For example, recent Henry Hub gas prices are approaching US$9 per million BTU (Figure 14).
Methanex is currently hedged for the majority of its natural gas prices for the Geismar facility, as per its annual report:
We currently have hedges and fixed price supply agreements for approximately 70% of all natural gas requirements on average for the Geismar facilities for 2022 to 2023 and a declining percentage at fixed prices continuing to 2032. The balance of our gas requirements are purchased at spot prices.
However, hedges roll off eventually, and if natural gas prices remain high in 2023 and beyond, it may negatively impact Methanex's margins and earnings. Note at $9 per mmbtu, natural gas alone will cost $250 to $280 per ton of methanol.
Regional Methanol Prices May Detach From Fundamentals
In general, methanol prices fluctuate based upon its marginal cost of production, i.e. natural gas and coal prices. However, since Chinese methanol prices peaked in early 2021, this relationship seems to be broken, as global natural gas and coal prices have rallied significantly while methanol prices in China are down by 40%.
As we touched on briefly, methanol pricing is highly regional. Depending on supply and demand in various regions as well as storage and pricing dynamics, methanol pricing can vary greatly between regions. For example, in Q1/2022, methanol prices slipped in China as storage was full while US prices remained firm as natural gas supplies were tight.
For Methanex, there is a risk that even as its production costs rise (methanol produced out of Geismar in the U.S. with increasing natural gas costs), its regional selling price may fall (oversupplied market in China). As analysts, it is hard to model Methanex's realized pricing due to the global nature of the methanol market and regional price differences.
Construction Costs May Overrun On G3
Another risk for Methanex is that its costs to construct Geismar 3 may run above budget. With producer price inflation above 11% in June , it is not difficult to imagine a scenario where the remaining construction costs on Geismar 3 may come in significantly over budget.
Debt And Economic Sensitivity
Furthermore, Methanex is a fairly indebted company, with $2.9 billion of debt and lease liabilities. While cash generation is projected to more than be sufficient to complete the G3 project and maintain the current dividend and buyback program (Figure 15), there is significant downside risk to these figures. For example, Methanex's realized price per ton was $295 in 2019 and $247 in 220. Per figure 15, $50 in realized price is worth $700 million in FCF. If the global economy were to enter a recession and methanol prices fall to $300 per ton, Methanex's balance sheet could be in jeopardy.
Figure 15 - cash flow bridge to G3 (MEOH investor presentation)
Technical Analysis
Technically, MEOH has broken down from a large wedge formation and is attempting to rally above the $29 pivot level at 2021 lows. Key moving averages now become resistance, with the 150 DMA at $47 (Figure 16).
Figure 16 - MEOH broke from wedge (Author created with price chart from stockcharts.com)
Conclusion
In summary, Methanex is a global leader in methanol production trading at cheap valuations on P/E and fair valuations on operational replacement cost. However, it's a highly cyclical business, so investors should be wary of projecting too far into the future. There are long-term tailwinds to Methanex, particularly its 1.8 mmtpa expansion at Geismar that should contribute significantly to cash flows once completed. Long term supply / demand dynamics are also favorable for the methanol industry. However, in the near term, risks are skewed to the downside due to macroeconomic concerns. Investors are encouraged to wait to accumulate shares closer to the completion of Geiser 3 or if Methanex trades significantly below replacement value for its operating plants.
For further details see:
Methanex: Premier Methanol Producer But Commodity Pricing On The Downswing