INSIGHT: Chem stock price collapse exposes low valuations, scepticism

Source: ICIS News

2018/10/11

NEW YORK (ICIS)--The carnage in chemical stocks has taken valuations down into the single-digit range on a price-to-earnings (P/E) basis in many cases, highlighting investor scepticism on 2019 earnings prospects.

Third quarter profit warnings by PPG and Trinseo so far could be the “canary in the coal mine” for a downward revision in earnings estimates.

The 3.2% plunge in the benchmark US S&P 500 Index on 10 October was followed by another 2.1% decline on 11 October. Chemical equities had already been falling since early September, and most took further hits in the broader market collapse.

US-based coatings company PPG’s profit warning on 8 October triggered a sell-off – not just in the chemicals group – but the entire industrial sector, as it highlighted weakness in global automotive markets.

On 9 October, PPG fell $11.02, or 10%, to $98.56 before bouncing slightly the next day as activist investor Trian Partners announced a stake in the company. By the end of 11 October, it was down to $96.40.

Styrenics, polymers and synthetic rubbers company Trinseo issued its profit warning on 10 October, citing a slowdown in the automotive industry and continuing weakness in tyres, along with “uncertainty of global trade dynamics”.

Shares of Trinseo plunged 21% to $60.35 on that day, trickling down further to $59.51 by the close of trading on 11 October.

The weakness in the automotive sector highlighted by PPG and Trinseo is likely to trigger additional profit warnings or missed estimates among chemical companies as many are exposed to this key downstream group. Additional earnings warnings should come as no surprise.

However, with the shellacking chemical equities have taken in the latest downturn, valuations appear to already reflect further estimate cuts.

Veteran chemical analyst Frank Mitsch, now with Fermium Research, on 11 October initiated coverage of the group with “buy” ratings on Tronox and Eastman Chemical, both of which sport single-digit P/E multiples based on 2019 profit estimates.

“Over the past four months, Eastman’s shares have been taking a beating (not unlike others in the space), dropping 20% while the S&P 500 increased 4%. Among the concerns include Chinese tariffs, spot ethylene margins, higher raws, etc. Throw in end market concerns and it’s not hard to see this result,” said Mitsch.

“However, we at Fermium Research are also focused on [Eastman’s] continued transformation into a specialties centric company with 2018 expected to deliver over $350m in new business,” he added.

The specialties portion of Eastman’s business is “well on its way” to reaching 80% of total company profits, with an estimated 73% in 2018, the analyst noted.

While the company is a major exporter to China with around $1bn in overall sales, accounting for about 10% of total sales, “we believe Eastman is reassessing its trade flows and will rely more on its facilities in Singapore, Malaysia and JVs in China, which does introduce some logistics friction”, said Mitsch.

The analyst’s 2019 earnings per share estimate of $9.50 for Eastman is above the $9.32 consensus and represents a P/E multiple of 8.6x.

Mitsch’s top pick is titanium dioxide (TiO2) producer Tronox, which is one of the most undervalued in the chemical sector based on estimated 2019 earnings.

The TiO2 stocks – Tronox, Chemours and Venator – have by far the hardest hit in the chemicals group.

Applying the phrase “buy when there's blood in the streets”, the analyst cites management’s unwavering conviction that it will close its pending acquisition of Cristal, along with the TiO2 outlook not being as bad as the stock prices reflect.

After intense discussions with multiple players in the value chain, “it became clearer and clearer that the level of value destruction in TiO2 names did not match the expectations of the industry in terms of pricing and margins”, said Mitsch.

The analyst sees Tronox closing the Cristal acquisition by the end of 2018, and earning $1.82 per share (slightly above consensus) in 2019, representing a P/E multiple of just 6.4x.

THE NEXT TROUGH ANALYSIS

While a US recession does not appear imminent, Laurence Alexander, analyst with Jefferies, put out an analysis on what valuations would look like for a handful of chemical companies at the next trough.

For the most part, “steeper cost curves, widespread industry bottlenecks, better competitive behaviour in China, portfolio shifts and a decade of productivity investments” should support higher valuations than the 4x-5x earnings before interest, tax, depreciation and amortisation (EBITDA) multiples seen during the financial crisis of 2008-2009, said the analyst.

In the analysis, Alexander sees company valuations at the next trough at the following EBITDA multiples: BASF (6.3x), Celanese and Dow (5x), DuPont and Eastman (6x), Huntsman (7x), Orion Engineered Carbons (6x) and Trinseo (6x).

Current valuations, though beaten down, remain above these levels as recession signals have yet to be triggered.

“Until the yield curve fully inverts and other key recession indicators are triggered (wider corporate credit spreads, auto sales down over 10%, slower housing starts and durable goods orders down  over 5%)… we expect a portfolio mixing defensives, pricing power and ‘self help’ to outperform after earnings season,” said Alexander.

Company Stock price % decline* E2019 EPS P/E
AkzoNobel € 73.72 -12% € 3.29 22.4
Ashland $75.23 -13% $4.00 18.8
Albemarle $94.36 -35% $6.10 15.5
PPG $96.40 -21% $6.61 14.6
PolyOne $36.43 -23% $2.83 12.9
FMC $83.16 -16% $6.80 12.2
DowDuPont $58.97 -23% $4.83 12.2
Solvay € 105.55 -20% € 8.89 11.9
Methanex $73.78 -11% $6.85 10.8
BASF € 70.01 -29% $7.01 10
Westlake Chemical $79.54 -36% $8.68 9.2
Olin $23.44 -40% $2.62 8.9
Celanese $98.28 -18% $11.09 8.9
Eastman Chemical $82.02 -27% $9.32 8.8
LyondellBasell $97.08 -20% $11.25 8.6
Huntsman $23.59 -35% $3.46 6.8
Covestro € 61.84 -36% € 9.31 6.6
Tronox $11.65 -59% $1.77 6.6
Trinseo $59.51 -30% $9.86 6
Chemours $35.29 -39% $6.29 5.6
Venator $8.84 -67% $1.64 5.4

NOTE: Closing prices on 11 October
* From 52-week high

By Joseph Chang