The Chemours Company (therefore referred as (NYSE:CC)) is a spinoff chemical company from DuPont whose 3 main areas of products are titanium dioxide, fluorochemicals and specialty chemicals. Normal business activities include R&D, procurement of raw materials, refining of raw materials, distribution, sales and marketing, customer technical support and management of customer relationship, implying that CC is vertically integrated in the chemical value chain.
Adj. EBITDA margins of the 3 components differ greatly with Titanium dioxide being the highest at 17%, fluoroproducts at 13% and chemical solutions at 1%. The company has recently published a 5-point transformation plan of the company which plans to make it a leaner and competitive chemical company. The plan aims to provide structural cost saving of $200m in 2016 and another $150m in 2017.
Presently, CC is the market leader for its respective industries; 18% market share in TiO2; 22% in fluorochemicals; 25% in fluoropolymers; #1 producer in US for sodium cyanides.
Opportunity exists because:
CC is severely under-priced due to multiple sources of sell-off from recent months which either result from other reasons not associated with fundamental value of company or perceived excessive uncertainty and risks from macroeconomic conditions (which are cyclical), litigation methods and its seemingly unsustainable leverage level. Shareholders of DuPont will automatically receive 1 share of CC for every 5 shares they hold (Source: SEC filing). Suddenly acquiring a company with untenable liquidity coupled with cyclical headwinds, the typical dividend large core investor will dump its shares almost indiscriminately. Likewise for institutional investors which find that CC no longer fits the risk category of its portfolio.
Titanium dioxide prices are continuously depressed from capacity expansion of 270 small and medium Chinese firms which has led to a margin squeeze. At the same time, appreciation of the USD and unexpected depreciation of the Yuan threatened the prices of its titanium dioxide. Fear plays a huge part here where knee-jerk investors will dump shares facing bleak macroeconomic conditions, however temporary. Coupled with the fact that the company faces 3500 plaintiffs for PFOA abuse and mounting environmental liability, (Source: SEC Filing) uncertainty looms with regards to future litigation liability of the company. This can potentially cripple the company's finance. However, at this point, one may fail to realize that litigation, especially of such huge scale, tend to take several years, decades even, to resolve. One need not look further than the lawsuit being filed for drinking water pollution in 2001 as it is still being resolved with tests being conducted. Instead, shares are dumped indiscriminately for fear of bankruptcy of the company. Prices have crumbled about 80% from a high of $20.85 to its current level now.
Reasons for Optimism
Management has published a five-point transformation plan that plans to a) reduce structural cost by 200M by 2016E b) further 150M by 2017E c) growth guidance of 150M from portfolio optimization and cost reductions in Cyanide, Titanium oxide production and Opteon and d)sale of non-core asset particularly in the performance chemical component. Most times, such figures tend to be cooked up by management to appease shareholders and pacify concerns about liquidity. Can we trust them?
In 3Q 2015, corporate restructuring has shown signs of success exceeding its initial guidance with a $62M in EBITDA generation via shrinking workforce and a $140M proceed from sale of aniline facility to DOW. This should look like proof to anyone that management is not conjuring numbers up.
Strategy-wise, we are looking at an innovative company whose value chain allows it to continuously deliver relevant value to its customer. Through multiple R&D centers and a rough expenditure of 2% sale on R&D, CC has several proprietary products like Telfon and Opteon which help its clients to maintain compliance from stricter environmental regulations. More than that, its lowest cost structure resulting from its chlorination process to produce TiO2 allows it to retain its market leader position. Last year, it increased the price of Ti-Pure products by $150/mmt which is followed by a similar increase by Tronox and 15% increase of price of its Suva© refrigerants products.
And we might expect revenue for its cleaner products to accelerate as the theme of environmental preservation becomes more pronounced. COP21 in France has more than 850 attendees, spanning 43 countries as they pledge to reduce carbon footprints and usage of ozone depleting substances. CC will be there to capture new needs of its client through its offering, e.g. Opteon©.
More stringent environmental laws extend to its Chinese competitors as well. Laws are passed in China to mandate the transition of a sulfate to the cleaner chlorination process to produce TiO2 which many Chinese companies do not have the capacity and technology to do so; Over 98% of the titanium dioxide in China was produced via sulfate process. This may signal to us investors that competitive headwinds from China might tone down as they struggle to abide with new regulations.
Insiders probably agree with the prospect of the company as well. In August to November last year, Insiders bought a significant 159.7K units of common share directly from the market (Source: SEC filing, Form 4). This is a sign of vested confidence from the insiders who have stayed with the company ever since its development in DuPont.
Certain concerns about CC have been highlighted in another article on seeking alpha. Instead of discussing the magnitude of liability awarded to the PFOA case, which I think is speculative given that the make-up of other cases are unknown, a DCF analysis along with a comparative analysis will be done in this article to check if CC is truly poised for doom.
DCF to project litigation damages from PFOA lawsuit
The elephant in the room for CC is really the uncertain litigation damages of the 3500 plaintiffs of the PFOA. A DCF analysis adapted from an EPV viewpoint with the following assumption will be done to assess the fair value of the company given substantial litigation damages of 1.75 billion that is expensed over 10 years and analyze how restructuring affects the fair value of the company in light of its debt and litigation damages.
1) Zero growth in revenue.
2) 5-point transformation plan is successful and its effects follow the guidance of the CEO, company incurs another restructuring charge in 70M for more severance packages and transaction cost.
3) Static TiO2 market with no change in price or volume of TiO2.
4) Zero currency changes so adj. EBITDA from current quarter will remain constant.
5) Specialty chemical components' EBITDA margin improves over a 5-year period to 10%, which is 0.4x of EBITDA margin of Cyanco (cyanide products supplier of 25%).
6) Depreciation remains constant at 250 (conservative) equal to maintenance capex (according to Q2 2015 guidance) as the company does not grow while Capex reduced to 350M as per management guidance.
7) Free up of 200M of working capital within next 2 years.
8) Outstanding environmental litigation at 330M which is expensed in a straight line for the next 6 years.
9) Tax rate of 27%, WACC of 8%.
10) No dilution of shares from 181M.
|(Euros in Millions)||2016E||2017E||2018E||2019E||2020E|
|Improvement in EBITDA due to portfolio focus||0||150||150||150||150|
|Restructuring Cost||$ (98.0)||$ (90.0)|
|Reduction in Structural Cost (2016, run rate)||200||350||350||350||350|
|Sale of Asset||140|
|EBITDA from Operations||$876||$1,064||$1,175||$1,196||$1,216|
|Depreciation and Amortization||$200||$250||$250||$250||$250|
|Environmental Liability||$(55.0)||$ (55.0)||$ (55.0)||$ (55.0)||$(110.0)|
|Capital Expenditure||$ (450.0)||$(400.0)||$(350.0)||$(350.0)||$(350.0)|
|Net Change in Working Capital||$100.0||$100.0||$0.0||$0.0||€0.0||Terminal Value|
|Unlevered Cash Flow||$364||$565||$596||$611||$571||$7,104|
|Discounted Cash flow||€298||$523||$510||$484||$419||$4,826|
|Fair Value of Litigation Liability||$1,266.0|
|Equity Value||$2,086||Fair Value||$11.52|
|Number of shares||181.0|
From the DCF model, we obtain a fair value of $11.52 per share which is a very conservative estimate of the company given the listed assumptions. Robustness of assumption 2, 6 and 7 which drive most of the cost savings is corroborated from the Q3 earnings call which see successful EBITDA gains and the sale of the aniline facility to DOW for 140M. Although we might expect revenue to be negatively affected by unfavorable currency conditions, it would be offset by CC's increase in price, which it has done so for Ti-pure© of $150ttm and 15% for its Suva© products. And tabulating the number backwards, we see that a fair value of 2,713M is necessary to send the company to the abyss. That is 4,285M expensed over 10 years or 1.2M per lawsuit.
From the first lawsuit of (Bartlett), a damage of 1.6 mil was awarded to the plaintiff though no punitive damages was awarded. Setting the precedents for the next 3446 cases, there will be 5 more bell-weather cases. Of course, we expect litigation damages to vary widely from 1.6 million with some cases being thrown out completed. Thus an estimate average of 500k for at least emotional damage (according to Bartlett) will be used to aggregate the cost. Even with such aggressive assumption, the security is trading at a 215% discount from its intrinsic value, measured from its current market price of $3.65.
Name of Companies
EV / EBITDA
The Chemours Co.
Fair Value of Debt
Num. of Shares (in mil)
Source: Various companies' SEC filing
Valuation of CC with its peers also reveal that it is tremendously undervalued. On the right side, it shows an EV/EBITDA comparative analysis. Evidently, at present, CC is trading at a significant discount to its peers at 6.8X even as its EBITDA margin is overall higher than KRO and HUN. And we should expect CC to trade at a premium to its peers given its lowest cost structure, proprietary technology, effective price leadership and its upcoming restructuring process which will widen the cost gaps between it and its peers.
By applying the mean ratio to CC, and deducting off-balance sheet liability related to environmental liability and projected 1.75B PFOA litigation liability expensed over 10 years, we obtain an equity value of 1173 and a fair value per share of $6.5.
The current underpricing of CC must be regarded from a perspective of fear and uncertainty. There are risks from litigation damages, macroeconomic headwinds, capacity expansion from China and the risks are exacerbated by its highly leveraged capital structure burdened by debt through its spinoff from DuPont. Given its cyclical nature, its risk profile no longer fits that of what past DuPont holders are looking for - consistent and predictable dividends. This has triggered a sell-off. Such extreme pessimism presents a rare opportunity for an asymmetric reward/risk ratio. Of course, in the event that litigation damages awarded are significantly higher than expected, CC could face bankruptcy.
The success of its turnabout depends largely on its restructuring efforts and recovery of the TiO2 market. And the intrinsic value of CC must be continuously updated with respect to lawsuit outcomes from its PFOA trials and TiO2 price recovery. Otherwise, valuation has revealed to us that damages from its litigation have been overestimated by the fearful investor. A conservative target price of $6.50 to $11.52 presents a significant upside of 78% to 215% in the next 12 to 24 months as restructuring happens.
Disclosure: I am/we are long CC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.