In January, I called AdvanSix a "good operator" in a challenged industry, as continued cost savings and good operational performance were offset by the continued impact of falling sales. I furthermore called the earnings power at this low point in the cycle impressive while cash flow conversion was problematic.
When I checked the prospects in January, shares already traded at $25, having risen from a low of $12-15 since the spin-off in the autumn of last year. I hoped that disappointing Q4 results would offer a buying opportunity, and while outages hurt the final quarterly results, shares have only risen further to a range of $27-30.
A Quick Recap Of The Business
AdvanSix produces nylon, ammonium sulfate and chemical intermediates. These are in essence commodity-like businesses, and thereby did not fit to the higher-margin and more predictable businesses of Honeywell. Rather than selling the unit, Honeywell opted for a spin-off, which at the time had a market capitalization of just half a billion, a fraction of its $100 billion valuation.
Half of its sales are generated from nylon, with chemical intermediates and ammonium sulfate responsible for the remainder. While the nylon end-markets are fairly stable, the other markets are somewhat more cyclical. Key input in these production processes is cumene, which derives its pricing from crude. It should therefore be no surprise that both input and selling prices have been under a great deal of pressure over the past two years.
An integrated business model, access to cheap US natural gas, and operational excellence allow the company to be able to outperform its peers, yet it remains a commodity-like business after all.
The headline number of the business looks terrible. Sales still totaled $1.8 billion in 2013, but have fallen to $1.19 billion in 2016, notably as a result of declining crude prices, as discussed above. Volume developments were quite flattish over time. Volumes were down by a percent in 2016, but this is somewhat misleading. If not for the (un)planned outage in the fourth quarter, volumes would have been up by 4% for the year.
While input costs were largely to blame for lower sales, they have an impact on profitability as well. Adjusted EBITDA stood at $222 million in 2013, fell to $166 million in 2014, to $137 million in 2015, and came in at $96 million in 2016. It is very hard to see the appeal in this trend, yet this warrants a small explanation. The company had planned turnaround activities in Q4 of 2016, which was expected to impact EBITDA by $20 million. Yet outages lasted much longer and the final impact of it all came in at $64 million. If we add this back, adjusted EBITDA hit $160 million in 2016, an improvement from 2015 while being similar to 2014.
On the back of the large outages, net earnings fell from $64 million to $34 million for all of 2016. If we use the adjusted EBITDA number of $160 million, we can construct a preliminary income statement, after taking into account a full year of leverage as well. We know that depreciation charges run at $40 million a year. The company operates with $15 million in cash, $250 million in net debt and has $33 million in pension-related liabilities. Using a 4-5% cost of debt reveals that interest costs come in at roughly $10-13 million a year. That leaves earnings before taxes of $107-110 million, or $70 million after applying a 35% tax rate. That is equivalent to $2.30 per share.
Net debt is fairly manageable given the current net debt load for a 1.6 times leverage ratio. At $28 per share, the adjusted earnings multiple comes in at just 12 times, even as operating conditions can hardly be called favorable.
As discussed before, cash flow conversion is not great with adjusted earnings running at $70 million. Depreciation charges hardly surpass $40 million a year. Capital spending came in at $84 million in 2016 and is seen at $90 million for 2017, resulting in very poor cash flow conversion ratios.
I hear you think, why would you invest so much if sales are not increasing? The reason is that maintenance capital spending is high and the company had/has to make quite some investments to meet more stringent environmental regulations. This trend has been going on for years, and unfortunately is not set to halt in 2017.
Optimistic Into 2017
Following a difficult end to 2016, the outlook is solid. The company notes that pricing of caprolactam and nylon 6 is solid on the back of lower supply and increased raw material prices. Furthermore, production rates are seen similar or higher than historical averages, after a significant maintenance period has already passed in Q4. Unfortunately no guidance was issued for the current year, but it seems fair to say that 2017 might become better than 2016's adjusted results.
Unfortunately, management failed to quantify the improvements on the conference call as well, leaving investors somewhat in the blind. However, the comments about solid pricing in some markets and high utilization rates make me believe that adjusted earnings are set to rise, as a $2.50 per share number should be within reach in my opinion. This results in appealing multiples at this point in the cycle, although cash flow conversion will again be very disappointing this year. Weighing it all together, I am a buyer on the back of the improved conditions if shares re-test their mid-20s, as they did in pre-market trading following the earnings release.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.