Methanex: On Track to Expand Production and Ramp Up Earnings

May.26.11 | About: Methanex Corporation (MEOH)

Methanex (NASDAQ:MEOH), a Canadian company, is the world's largest supplier of methanol. I wrote a piece on MEOH on March 2 that set forth the basic case for an enormous upside. Methanol is a very attractive strategy for displacing petroleum with natural gas and is increasingly being blended into the gasoline supply in China. The demand is strong and will likely remain strong as long as the substantial price differential between petroleum and natural gas continues.

This differential has become huge. Years ago, the industry standard was that a barrel of oil would generally sell for 10 times the price of an MCF of natural gas. At current prices the ratio is 25 rather than 10. On a BTU basis, oil is roughly four times as expensive as natural gas. This has created a situation in which there is an enormous and attractive incentive to somehow convert natural gas into a liquid fuel which can be substituted for petroleum products. Methanex dominates the methanol industry and has plants which can readily use natural gas(and other sources) as a feedstock to produce methanol which, in turn, can be used as a transportation fuel either alone or blended with gasoline.

Methanex has an extensive sales and distribution network and supplies roughly 7.5 million tonnes of methanol a year. It also has the capacity to produce roughly this amount of methanol itself. The problem has been that some of its plants have been idled due to natural gas supply problems. However, it has opened up new plants which should take its own production up to roughly 5 million tonnes from last year's total of a little less than 4 million tonnes. There is the potential to produce roughly 8 million tonnes if all of the idled capacity can be brought back on line; Methanex is taking steps to generate sufficient gas supply so that this can occur. As additional capacity comes on line, Methanex should be able to increase its profitability by either increasing sales or by reducing its purchases of methanol from other suppliers and substituting its own production.

MEOH's first quarter 2011 numbers were solid. Earnings and adjusted EBITDA increased significantly. MEOH increased its dividend 10% to 17 cents per share per quarter. Balance sheet cash increased by $46 million. MEOH traded at $28.35 when I wrote the March 2 article; it closed yesterday at $30.64.

The important thing to remember here is that the strong first quarter numbers did not reflect the impact of two new plants(one in Egypt and one in Alberta) that came on line in April after the quarter ended. These plants will produce additional output in the second quarter and thereafter, and should contribute to an upward trajectory in earnings.

There are always possible problems at different plants and the natural gas supply situation in New Zealand and Chile (where large MEOH plants are located) has been somewhat problematic. Investors should watch developments carefully and get a sense of the prospects for a higher level of capacity utilization, as that seems to be the critical factor that could move the stock sharply higher.

MEOH occupies a potentially critical strategic position in the energy market due to its ability to perform the modern equivalent of alchemy and essentially convert natural gas into a gasoline substitute. The dynamics of the energy markets are such that this conversion will become increasingly important and profitable. Very little capacity (other than MEOH's new plants) is coming on line in the next couple of years (although it appears that a plant will come on line next year in the United States) and the market should be tight.

MEOH offers substantial upside as it brings more of its capacity on line. It also provides a dividend so that an investor gets paid to wait while this ramp up in earnings materializes.

Disclosure: I am long MEOH.