Commentary: Chlor-alkali players Axiall and Olin take a hit

The stock prices of US chlor-alkali producers Axiall and Olin took another hit on 2 September, after a prolonged decline throughout the year, reflecting the widespread woes in the sector. Shares of Axiall fell $1.38, or 5.6%, to $23.20, while Olin slumped $1.16, or 5.9%, to $18.49. Axiall is down 55% from its 52-week high, while Olin is off 46%.

The latest falls followed a research note by investment bank UBS cutting profit estimates on both companies. On 2 September, UBS analyst John Roberts downgraded his rating on Axiall from “neutral” to “sell”, but upgraded Olin from “neutral” to “buy”, despite reducing earnings estimates.

“Given our view that petrochemical prices will adjust for lower oil prices and pricing for vinyls is loosely linked to oil due to ethylene being the largest raw material, we are reducing [profit estimates],” said Roberts. “In spite of being shale-gas advantaged, the chlor-alkali market has been among the more depressed areas because of recent expansions, underperforming global construction markets, and concern over China’s growth.”

Caustic soda, a byproduct of the chlorine production process, is suffering from dislocations in the important alumina end market. Shutdowns of alumina refineries worldwide amid weak pricing are expected to lead to further oversupply of caustic soda, as ICIS pricing editor Bill Bowen notes on page 12.

For Axiall, Roberts cut his 2016 earnings per share estimate by $0.35, to $1.45, and his 2017 forecast by $1.45, to $1.80. Olin’s estimates were cut far less severely – by $0.04, to $1.71 for 2016, and by $0.10, to $2.15 for 2017.

Roberts favours Olin over Axiall based on a higher dividend yield of over 4%, significant expected cost savings from its merger with Dow’s chlor-alkali operations in a Reverse Morris Trust (RMT) transaction in early October, and back integration into ethylene at favourable economics as part of the Dow deal.

Even in the face of a ratings upgrade by UBS, Olin tumbled along with its chlor-alkali counterpart

Could traders be setting up short positions in Olin already based on announced details of the exchange offer with Dow?

Dow revealed the terms of the equity swap in the RMT transaction, detailed in a research note by Wells Fargo analyst Frank Mitsch. Dow will start an exchange offer to distribute 87m shares of Olin that will be issued to Dow in exchange for the chlor-alkali assets, to Dow shareholders.

As revealed in an amended S-4 filing with the US Securities and Exchange Commission (SEC), Dow shareholders will receive Olin shares at an exchange ratio that will be at a 10% discount (subject to an upper limit). Essentially, Dow shareholders will be getting a more favourable deal in swapping their shares for Olin shares as an incentive to participate in the exchange offer, noted Paul Young, analyst at Wells Fargo’s risk arbitrage desk.

The exchange ratio will be determined in a 3-day period from 28 September to 30 September based on the volume weighted average price (VWAP) of Dow and Olin. The 3-day VWAP of Dow will be divided by 90% of the same for Olin to get the exchange ratio.

Assuming the exchange ratio was based on the closing prices of 2 September of $42.39 for Dow and $18.49 for Olin, (it won’t be and these are also single price points rather than VWAPs over three days), a Dow shareholder would get 2.55 shares of Olin, or Olin shares worth $47.15 – 11% above Dow’s current price.

In a static world, an investor would be incentivised to buy Dow’s stock now, knowing it can be exchanged for a greater value in Olin stock. Yet in reality, the returns would hinge on the fluctuations of both stock prices.

Wells Fargo expects arbs (investors seeking relatively risk-free returns by taking advantage of price spreads) to buy Dow stock and short Olin, mostly during the three-day period.

For beleaguered long-term investors in Axiall and Olin, they can only hope to one day exchange their shares for higher prices as the chlor-alkali cycle bottoms, and turns up again.