4 Months Ago, I Liked Celanese, And Now?

|
About: Celanese Corporation (CE)
by: The Investment Doctor
Summary

Celanese had an excellent 2018.

2019 will be much tougher, and the EPS guidance seems to hide the expected drop of the underlying profit due to the share repurchase plans.

Celanese isn't a sell. But It could get cheaper.

Introduction

In November, I made a case for Celanese (CE) as I argued the company’s cash flows wouldn’t remain under the radar for much longer. Sure, the chemical sector is and will always remain volatile due to its cyclical nature, but that doesn’t mean you can’t book any investment profits on these types of companies as long as you are aware of the correlation with the economic cycle. When the world economy does well, the results of the chemical sector will be excellent, but the opposite is also true; during dark times, on the economic front, chemical companies will be hit pretty hard.

Chart Data by YCharts

Now, Celanese has reported its full-year results, and as it also provided a guidance for the current financial year, I thought this was a good moment to put my finger on the pulse again.

The full-year results are in, and the free cash flow was massive

Not entirely unexpected, Celanese was able to report record earnings as the entire chemical sector performed quite well in 2018, and Celanese wasn’t an exception.

It once again reported a revenue increase of in excess of 15% while the total production cost of its output increased by roughly 10%, resulting in a substantial increase of its gross profit and operating profit which increased by almost 56% to $1.33B. Thanks to a lower average tax rate, the net income of Celanese was approximately $1.21B, which is $8.99 per share on a reported basis, and $11/share based on Celanese’s non-GAAP adjusted result.

Source: annual report 2018

Great. So far, so good. But it’s tough to deny a visible slowdown in the fourth quarter. Whereas Celanese generated 26% of its 2017 revenue in the final quarter of the year, this dropped to less than 24% in the most recent full quarter. You can also see a similar impact on the operating margins. On a full-year basis, Celanese’s operating margin came in at 18.64%, but the operating margin was just over 15% in Q4 2018, dragging down the full-year margin as Celanese’s operating margin in the first nine months of the year was 19.74%. Definitely something to keep an eye on, and it explains Celanese’s soft outlook for 2019 (see later).

Source: annual report 2018

Cash flow-wise, Celanese reported an operating cash flow of $1.56B, and after making the necessary adjustments (tax, payments to non-controlling interests, working capital changes), the adjusted operating cash flow for the year was $1.65B. With a capex of just $337M, Celanese generated a total free cash flow of in excess of $1.3B. Plenty of cash to cover both the stock repurchases ($805M), dividends ($280M) and the acquisitions in 2018 ($144M). Using the 128.1M shares outstanding, the free cash flow per share came in at approximately $10.20.

Now, the US Dollar remains strong, I hope Celanese plans to repurchase its 300M EUR of senior debt expiring in October. This debt has a 3.25% coupon, and at the current exchange rate, Celanese would save $11M in interest expenses per year while taking advantage of the strong Dollar to pay just $340M for the 300M EUR.

Source: annual report 2018

But what about the future? How does 2019 look?

Celanese says the ‘underlying fundamentals and demand forecasts for its products remain strong’, and the company continues to guide for an EPS of $12.00 in 2020 (next year). So far, the good news, and you immediately notice the company goes straight to its 2020 guidance in the outlook.

And, with a good reason, as Celanese has definitely felt the impact of a slowdown of the world economy, and it’s pointing the finger at Europe and Asia for a weaker-than-expected performance in the current quarter. On top of that, Celanese doesn’t expect the situation to be solved soon, as it expects the headwinds to persist into the second quarter.

That’s why its near-term outlook for 2019 appears to be a bit more disappointing than its longer-term outlook for 2020, as it expects to generate an adjusted EPS of just $10.50 in the current financial year. This would be a drop of almost 5% compared to FY 2018 which by itself already is a tough setback, but I am very curious to see the net income expressed in dollars as well, as Celanese continues to buy back stock which boosts the EPS but very likely hides an even weaker underlying net income.

Source: annual report 2018

Celanese ended the year with 128.1M shares, compared to the 135.8M shares as of the end of 2017, and the average share count of 134.3M throughout 2018. This seems to indicate the drop in the adjusted net profit might actually be closer to 10% when looking at it in absolute dollar value rather than EPS.

Source: company presentation

Investment thesis

Celanese’s 2018 was excellent, but 2019 is shaping up to be a tough year for the company as it has to deal with a slowdown on the European and Asian markets. Its preliminary guidance is to generate an adjusted EPS of $10.50 in 2019, but Celanese has promised to provide an update and finetune this number when it reports its Q1 results, and I think we cannot rule out a further deterioration of Celanese’s guidance.

Despite these headwinds, Celanese remains an interesting way to gain exposure to the production of high-performance polymers and acetyl products.

Disclosure: I am/we are long CE. 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.

Additional disclosure: I have a small long position in Celanese, and could write out of the money put options on share price weakness.