Is Celanese, like Freeport (FCX), another growth-in-emerging-markets story?
Ronald Mushock: In many ways, yes. The company is a global producer of chemicals, used for a wide variety of industrial- and consumerproduct applications. It’s a leader in things like acetyl products and high-performance engineered polymers that show up in everything from filters to plastics to adhesives.
There are a couple big parts to the story here. Celanese is in the process of a long-term restructuring of its business – five years ago, it generated 70% of its revenues from commodity chemicals andonly 30% from specialty lines. This year, it should be closer to 60% specialty and 40% commodity, which has resulted in strongly increasing margins that we don’t think have been fully incorporated into the shares’ valuation. Because chemicals like acetates are used in a wide variety of products used in construction, this is also a play on overall infrastructure growth in developing countries. Celanese currently generates 60% of revenues from outside North America, with particularly high growth in Asia, fueled by China’s strong demand for industrial commodities. That secular growth shows little sign of abating and the company is building on it relative strength there by adding significant capacity – including an acetate plant in Nanking, China – to take advantage of it.
The chemicals business is notoriously cyclical. Where do you think Celanese is in its earnings cycle?
RM: That’s obviously difficult to say, but we do think this cycle for Celanese is different. Prior cycles were U.S.-driven and the period of positive earnings for chemical companies usually ran for one or two years. That normal up and down of the business has been interrupted by the new industrial revolution in China and other developing countries, which is creating much longer-term demand for all types of commodities, including chemicals. We’re clearly highly attuned to this, but we’re not seeing a break in that positive momentum. Chemical-company pricing power remains very strong – every couple of weeks Celanese announces another price increase for one of its product lines. Also, as capacity utilization increases, there’s obviously a lot of leverage to operating earnings. We see the company continuing to grow EBITDA in the low double-digits, on 5% or so annual revenue growth.
To what extent is the stock, now trading just under $41, not reflecting the business potential?
RM: We believe the consensus earnings estimate of $3.50 for next year is too low by about 50 cents. On top of that, if you look at where Dow Chemical trades on the commodity side and Rohm and Haas trades on the specialty side, we’d expect Celanese to more appropriately trade at around 14x 2008 earnings, rather than the current 11.8x. The higher valuation on better earnings would give us a stock price in the mid-$50s. Huntsman – which has a very similar business mix to that of Celanese – recently agreed to be bought by Hexion Specialty Chemicals for 18x earnings. At that level, Celanese would be worth closer to $60 per share. Like with Realty Income, this isn’t the most exciting business, but it’s what we do: it’s a P/E-expansion play, an international play and it’s something that ultimately has appeal as a part of a larger diversified chemical company.