Chemours: Heading To $0? Not Likely As Outsized Gains Are More Probable

| About: The Chemours (CC)

Summary

The company’s shares have been volatile to the upside and downside as it has faced adverse business conditions, a short seller attack and high-profile litigation damage awards.

A highly biased and hyperbolic short-seller declared the company “morally and financially bankrupt” and likely to go bankrupt in 18 months due to litigation damages.

A bond research company called the short seller’s bankruptcy prediction “highly unlikely” and indicated that Chemours had numerous long-term paths to survival.

Media reports of multi-million dollar litigation damage awards neglect to state that most cases the company faces are not “bellwether” cases and involve much lower damages.

An informed investor will be rewarded with outsized gains by recognizing the true cost of any litigation damages the company faces and the company’s transformation plans.

Owning shares of the Chemours Company (NYSE:CC) since it was spun off from DuPont (NYSE:DD) has presented shareholders with nothing less than a terrifying roller coaster ride of steep share price drops and upward surges ranging from 10 to 20 percent in either direction. The company's shares have become a day trader's dream stock. CC, a global chemical company with leading market positions in titanium technologies, fluoroproducts and chemical solutions, initially sold off after its spin-off because of weak demand, high inventory levels and substantial exports from China that have caused a significant price decline in the company's flagship Titanium dioxide ("TiO2") product. After the initial post spin-off sell off in CC shares, however, two news items have figured prominently in the volatility in the trading of the company's shares. Central to each news item is that the company is facing potential substantial environmental remediation and litigation liabilities due to its sale of Teflon products that contained Perfluorooctanoic acid ("PFOA").

The first news item relating to CC's PFOA litigation's involves a prominent short seller's ("Citron") opinion about CC and the outstanding litigation damages it faces. On its face, we find such short seller's opinion hyperbolic, one-sided and clearly biased given such short seller's short position in CC's shares. Citron stated that CC "is the most morally and financially bankrupt company that we have ever witnessed" and that highly material events for CC "are unfolding nearly every day" regarding DD's liabilities due to its manufacturing of PFOA, and "its 60 year pattern of willfully hiding its knowledge that the chemical was toxic at extremely low levels of exposure, and was being dumped into the environment at its facilities." Citron pointed out that DD dumped its liabilities onto CC. Citron concluded that CC has not posted reserves on its balance sheet for its "snowballing" legal and environmental costs and that CC was designed to go bankrupt and the only question was when. CC, of course, immediately refuted Citron's claims. Much of the financial news media immediately regarded Citron's financially motivated and clearly biased opinion as the gospel truth without questioning the veracity of Citron's claims and CC shares plummeted by double digits. We should note, however, that the bond research company CreditSights called Citron's CC bankruptcy prediction in 18 months "highly unlikely" and indicated that it saw "numerous paths to survival over the longer term." CreditSights also called Citron's $5 billion PFOA litigation damage estimates exaggerated. Citron's position, however, as any independent thinking investor would recognize is fear mongering at its finest and designed to create a sell-off in CC shares. Citron's opinion has been effective near-term, but there is more to the PFOA litigation story.

The second news item related to a damage award regarding an early PFOA trial. CC shares fell over 20 percent within minutes after a jury awarded a man $5.1 million, finding DD liable (and CC will bear the cost) for the man's testicular cancer in a test case among 3,500 lawsuits. CC said it would appeal the verdict, but the damage was done to its shares. Quietly, after hours CC made a SEC filing stating that the $5.1 million in damages related to testicular cancer and that the case "was selected by the plaintiffs as one of the six bellwether cases." The company noted that the "remaining two bellwether cases, both alleging kidney cancer, were resolved for an amount well below the incremental cost of preparing for trials." The company continued stating that all six bellwether cases were tried, resolved, appealed or otherwise addressed. DD is the named defendant in each of these cases and is directly liable for any judgment (but CC is the indemnifier). CC concluded by stating that the majority of the 3,500 cases "allege high cholesterol and thyroid disease" and that each case would be evaluated on an individual basis due to the unique facts present in each case. The financial media did not extensively report CC's filing, but such filing effectively states that the earliest "bellwether" cases were the cases involving the greatest harm to plaintiffs and the highest likely damage awards. The remaining cases involve health issues much less severe than the early cases and are likely to involve much lower damage awards.

Just when investors proclaimed the world was coming to an end for CC and its shareholders, CC's surged higher by over 15 percent in a single day as the punitive damages for the $5.1 million award case noted above were lower than expected. Investors felt that the awarded $500,000 in punitive damages reduced the potential burden on CC and DD. Plaintiff in the case had been seeking punitive damages figures as high as $1.2 billion. DD and CC are appealing the punitive damage verdict as they are every PFOA litigation verdict to date noting that "interim results don't predict the final outcome of such a lengthy litigation." Of the six test cases to date, two had rulings against DD, one was not tried and three were settled. A litigation analyst considered the $500,000 punitive damages award a "positive signal" for CC, stating that the amount figure removed the possibility of a "potential layer of punitive damages." Another analyst estimated that CC "could face $1.2 billion to $1.9 billion in liabilities for about 603 cases classified as the most serious." After six test cases have been resolved, 40 more cases will proceed to trial in April 2017 unless DD settles the outstanding cases.

What we have learned to date from the results of the PFOA test cases against DD and CC is that: 1) the worst cases with the highest likely damage awards are being litigated first; 2) many of the remaining cases relate to injuries that are far less than the test cases and are likely to result in much smaller awards; 3) punitive damages awards may turn out to be much less than anticipated; 4) DD and CC are appealing all cases and the PFOA litigation process will be lengthy; 5) a highly biased short seller has an overstated hyperbolic opinion against DD and CC that is controverted by the facts; 6) traders are whipping CC shares up and down on every bit of news; and 7) with the highest damage cases representing a smaller portion of the total cases, DD (and the indemnifier CC) will be more likely to afford the likely damages and settle the remaining cases as well. We should note that CC will likely pay the damages over a period of time to the benefit of CC. We should also note that the longer the litigation stretches on, the more CC can sell assets to shore up its cash reserves and can restructure and improve its businesses to improve cash flow. With this in mind, CC has been working to restructure its businesses for over a year now to improve results.

Since being spun-off from DD, CC has been engaged in a transformation plan that it announced in 2015 to consolidate and strengthen its TiO2 business as part of a five-point transformation plan. Such plan to become a higher value chemistry company includes five elements: 1) reducing structural costs; 2) growing market positions; 3) refocusing investments; 4) optimizing its portfolio; and 5) enhancing the organization's production capabilities. As part of such plan, CC indicated it would close a TiO2 plant and a TiO2 line at another plant. Such shut downs decrease TiO2 capacity and allow CC to refocus its production of such product at four manufacturing sites that employ the full range of the company's technological strengths. At the time CC announced its transformation plan, it indicated that such plan would enhance its adjusted EBITDA by approximately $500 million, without relying on improvement in the TiO2 market, and also would reduce its leverage to about three times net debt to adjusted EBITDA in 2017. CC, when it was a part of DD and as an independent company, has been experiencing significant pricing pressures with respect to its flagship product TiO2 as global prices for such product have decreased significantly from its peak prices. Weak demand, high inventory levels and substantial exports of the product from China have caused the severe TiO2 price drop.

CC's most recent earnings results reflected improved results as the company continued to execute on its transformation plan by reducing costs, growing market positions, optimizing its portfolio, enhancing its organization and refocusing investments. The company realized over $40 million of cost savings in its latest quarter, and it continues to aim towards $200 million of savings in 2016. Demand for the company's Opteon product increased significantly as automotive manufacturers prepare for new refrigerant regulations. The company also divested a business for $230 million from its chemical solutions division as it conducts a strategic review of such business. The company also engaged in working capital initiatives across all of its businesses resulting in the reduction of seasonal cash use that significantly improved free cash flow. Specifically, CC continued to build liquidity through working capital productivity, asset sale proceeds and a DD prepayment for certain goods and services, resulting in a cash balance of $435 million. As of March 31, 2016, CC's gross consolidated debt was $4.0 billion. Debt, net of cash, was $3.6 billion. Finally, CC's execution of its transformation plan is putting the company on track to $500 million of improved EBITDA in 2017 over 2015, significantly improving free cash flow and reducing its net leverage.

We should point out that CC faces a multitude of significant headwinds. We should also note that the company is working effectively against each adverse circumstance it faces. A seasoned investor should realize, however, that the greatest gains come from the darkest hours of a company that much of the investor community is against. How many investors bought Apple, Inc. (NASDAQ:AAPL) shares in 1996 when it was said to be six months from bankruptcy and all of the financial media was against it? We did. The same can be said for CC. We are saying that a speculative 500 or 1,000 share bet on CC shares may very well pay off in a several hundred percent return in three to five years. On a more comforting note, we have repeatedly noted in prior articles that CC insiders have bought significant amounts of shares on two occasions and such purchases are likely a sure sign of their belief that CC will survive and thrive the adverse business and PFOA litigation circumstances it currently faces. Ultimately, CC is facing adversity through change and not waiting for TiO2 prices to increase the company's revenue and earnings. Instead, the company is in the midst of the above-described five-point transformation plan to cut costs while TiO2 prices are at a cyclical bottom. The company plans to improve its EBITDA through cost cutting, growth initiatives and reducing net debt leverage. A speculative bet on CC shares is likely to pay off handsomely.

First quarter 2016 earnings

In early May 2016, CC announced net sales were $1.3 billion, a 5 percent decrease from the year-ago quarter. Net income was $51 million ($0.28 per diluted share), an increase from $43 million ($0.24 per diluted share). Adjusted EBITDA was $128 million, a decrease from $145 million due to lower average prices in titanium technologies and adverse currency effects that were partially offset by improved profitability in Fluoroproducts and chemical solutions. CC's titanium technologies-business sales were $521 million, a 4 percent decrease. Adjusted EBITDA for such business was $54 million, a 42 percent decrease due to lower year-over-year pricing and adverse currency effects. The company's Fluoroproducts-business sales were $531 million, a 4 percent decrease. Adjusted EBITDA for such business was $85 million, a 13 percent increase due to Opteon sales growth and broader participation in fluoropolymers markets that were more than more than offset by weaker demand for fluoropolymers in consumer electronics, regulated volume reductions of base refrigerants and adverse currency effects. CC's chemical solutionssales were $245 million, an 8 percent decrease due to pass-through impact on prices of lower raw material costs and softness in spot market pricing. Adjusted EBITDA was $10 million, $9 million increase due to transformation plan initiatives that are decreasing operating costs.

CC expects adjusted EBITDA for 2016 to be above its 2015 performance, generating modestly positive free cash flow. The company continues to focus on improving its profitability for its Titanium Technologies through cost reductions and modest price increases.

Our views

The headline risk for CC and its shares is significant given the financial news media's bare bones reporting of any adverse damage reward relating to the company's legal responsibilities for any damages arising from the PFOA litigation cases. With that said, such financial media tends to gloss over facts relating to the entire group of PFOA cases and just focus on the damage numbers resulting from the most high profile damage awards from such cases. Add in a very vocal but highly-biased short seller with a financial stake spouting impending doom for CC and you have a nightmare scenario for investors. A calm and informed investor, however, could view the litigation circumstances CC faces with clarity and realize that such circumstances are not as dark as the media portrays. Therefore, a measured and modest investment in CC's shares by an informed investor is likely to provide outsized returns in the intermediate term.

Although CC faces headline litigation risks and adverse market conditions, the company remains a global leader in TiO2 production with a low-cost asset base given its size, scale and ability to use cheaper raw materials in its production. Weak demand, high inventory levels and substantial exports from China have caused a significant TiO2 price decrease, CC's most significant product. The company, however, has been aggressively addressing such negative headwinds through its above-described five-point transformation plan to cut costs while TiO2 prices are approaching a cyclical bottom. The company is also improving its EBITDA through cost cutting, growth initiatives and reducing net debt leverage. In addition, the company is attempting to mitigate its potential environmental liabilities through proactive litigation strategies of fighting early cases aggressively to hold down potential damage liabilities.

CC forward price to earnings ratio is 11.30 based on 2016 earnings estimates of .68 a share and 6.50 based on 2017 earnings estimates of $1.18. The company's shares have a dividend yield of about 2.00 percent. With the above-described negative market conditions in mind, we should note that investors who are more risk averse should avoid CC shares as an investment until the share price stabilizes. Investors with a higher risk tolerance, should follow the lead of multiple insiders who made insider purchases on two occasions in late 2015. We tend to believe that CC insiders have a greater knowledge (as opposed to analysts, investors and a highly biased short seller) about the market conditions the company faces, the success of the company's ongoing transformation plan and the company's damage exposure as a result of the PFOA litigation cases. To us, the ongoing multiple insider purchases are the strongest indication of such insiders' belief in the company's plans to cut costs, reduce net debt and mitigate litigation liabilities while it waits for the TiO2 pricing cycle to turn upward. As noted above, a modest investment in CC shares now is likely to pay outsized returns over the intermediate term.

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Disclosure: I am/we are long CC, DD.

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.