The Chemours Company: Quality Business At Attractive Prices Due To Industry's Cyclical Bottom

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About: The Chemours Company (CC)
by: Khin Wai Ho
Summary

The market misunderstands Chemours as a typical toxic chemical business - when it should focus on its strong and defensible moats.

Chemours' shares are currently trading at one of the lowest EV/EBITDA (~5x) in history - in part due to industry's cyclical bottom.

We think investors' downside risks are limited as Chemours boast huge free cashflow and strong financials to buffer any external short-term performance impact.

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Investment Thesis

The market has misunderstood Chemours (CC) as a typical chemicals firm and has priced them as such. Chemours has strong, defensible moats - including a patented chlorine-based TiO2 technology that reduces costs, improves operational delivery, and which a substantial number of customers rely on. Such characteristics move Chemours out of the typical industry cycle. We feel confident that their strong fundamentals limit the downside, while presenting an attractive entry point right now.

Introduction and Business Moat Analysis

Chemours is a chemical company that was spun off from former parent, DuPont (DD), in 2015. They are a market leader in Titanium Technologies (48%), Fluoroproducts (43%), and Chemical Solutions (9%) with brand-name products like Teflon, Ti-Pure and Opteon. These products (ingredients) are used in plastics and coatings, refrigeration and air conditioning, mining and oil refining operations, and in general industrial manufacturing.

Chemours is unlike any other industrial chemical company. In each segment, they have become the market leader due to certain competitive advantages that have sustained over many years.

Titanium Technologies

Chemours is one of the few manufacturers using a chloride process (that's a trade secret) - in which, gives them a cost-, efficiency-, and margin-advantage.

According to McIntyre Partnerships, no other competitor in over 70 years has come close to competing with Chemours' processes. What's more, Bai-Max is only exclusively produced for customers in the Greater China region, indicating that such processes are highly specialized and not easily substitutable. This means that Chemours' customers in China are essentially "locked-in", which gives Chemours sufficient pricing power.

Fluoroproducts

Chemours is a global market leader in fluoroproducts as well. Moreover, their complex production creates high entry barriers, while their supply chain is diversified (by not simply relying on China) and kept cost-competitive with their contracts averaging 5 years. Chemours also holds many patents in this segment that will expire from 2019 through 2034.

Chemical Solutions

Chemours holds and licenses these leading process technologies (trade secrets) for producing hydrogen and sodium cyanide - which is used in industrial polymers and gold production. They gain efficient distribution advantages in deliveries to customers by having a robust network of logistic providers, and strategic geographical placement of production facilities. Customer loyalty is also locked in due to Chemours/DuPont's long-term relationships and excellent past customer track record. Thus, Chemours' sales are generally much more stable than a traditional chemicals firm.

The Numbers

We start with the basic revenue figures below, discarding 2015's results as the spinoff happened in mid-2015. Thus, any "annual" figures reported for FY2015 will not be accurate. Starting from FY2016, we see that revenues and net profits have been consistently growing - which indicates that Chemours had experienced pure growth without relying on DuPont's scale moats.

https://i2.wp.com/khinwai.com/wp-content/uploads/2019/05/image-6.png?w=700&ssl=1

(Source: khinwai.com, data from Bloomberg)

In analyzing the profitability measures, we compare Chemours' numbers to the closest S&P 400 Materials Sector GICS Level 1 Index benchmark (seen below).

We see that ROIC and operating margins are at ~20% for the recent two years - which is highly likely due to the efficacy of its moats showing. ROA has also increased above 10% (not shown) - indicating that they use their assets very well. The ROE is not stabilized as yet - as their Retained Earnings have been building up since the spinoff, which had impacted their Equity position.

https://i0.wp.com/khinwai.com/wp-content/uploads/2019/05/image-3.png?w=700&ssl=1

(Source: khinwai.com, data from Bloomberg)

In all aspects, we see that Chemours has outdone the overall competition. Not only that, they have managed to increase their metrics from 2017 to 2018.

On the debt side, we see that D/E is 400x (2018) while the Gearing is at 54%. Typically, companies in the materials industry experience such high levels of debt due to the capital intensity of carrying out the expensive business processes of raw material logistics, energy usage and industrial production.

In any case, we take comfort that the Interest Coverage for Chemours is a healthy 6.07 times in 2018. This should give us confidence that Chemours will have no problems repaying their debts.

https://i1.wp.com/khinwai.com/wp-content/uploads/2019/05/image-7.png?w=700&ssl=1

(Source: khinwai.com, data from Bloomberg)

Lastly, looking at the free cash flows, we see that Chemours consistently generates positive Free Cash Flow. And in 2018, FCF rose to almost 650 million USD - which is definitely a good sign.

https://i2.wp.com/khinwai.com/wp-content/uploads/2019/05/image-4.png?w=700&ssl=1

(Source: khinwai.com, data from Bloomberg)

Competent Management

The president and CEO of Chemours is a Mr. Mark Vergnano, who has over 30 years of chemical industry experience at DuPont. We have no doubts about his competencies to lead Chemours' growth - seeing how he has managed to drive such amazing quantitative figures above as compared to his competition.

We also look at the overall executive compensation structure for 2016 (when they first spun off) and in 2018 (the most recent annual figure). Straightaway, we see that "non-equity incentives granted" shrunk quite significantly … and that stock and options awards grew.

(Source: khinwai.com, data from Bloomberg)

This can definitely signal a positive alignment with shareholders - as management now has some skin in the game. However, the stocks and options granted might be contracted at a big discount that a typical investor cannot get. Moreover, exercising those options might mean value dilution for existing shareholders. However, seeing that majority of compensation comes from direct stock awards, we need not worry too much.

Growth Opportunities

There is much runway for growth for Chemours - especially since their market cap is only $6+ billion USD (mid-cap). As a spin-off company, they now has more agency to develop their core competencies by leveraging on their existing patents, diversified supply chain and dedicated distribution network.

Moreover, as global markets and governments around the world are moving toward more sustainable products, Chemours is well adapted to capture that growth. They are currently already a market leader in the flurochemicals subsegment. They have a leading position in ozone-safe HFC refrigerants under the "Freon" brand and environmentally-friendly patented "Opteon" technology to be used in refrigerants and cooling devices. Thus, demand could be driven higher when regulations lean toward more ozone-safe products.

Risks

Currently, the top 10 customers for Titanium Technology segment make up 35% of segment's sales. Moreover, one customer represented >10% of this segment's sales. This means that if a competitor can sufficiently compete against Chemours' chloride processes, Chemours could be materially impacted in their revenues and profits as they lose a key competitive advantage.

Fluoroproducts and Titanium Technologies segments' demand grow with GDP. This means that revenue and profit performance will not hit expected targets in the event of a recession or market downturn. Moreover, TiO2 is subjected to sales seasonality, which could see Chemours posting lower sales and profit figures for certain quarters of the year. However, we feel that this should not impact the long-term operations of the business - as Chemours can buffer these short-term losses with a growing cash pile.

Attractive Valuation

We see from the below chart that Chemours has come down a whole lot in terms of historical valuation. As at FY18, Chemours trades at around 5x EV/EBITDA. If we look at trailing TTM PE, we get about 6x P/E. It is a highly desirable value play - although the time frame for value realization could extend from 3-5 years, as institutional investors start to discover this stock (assuming revenue, profits and cashflows grow at the current rate).

Chart Data by YCharts

Considering that the chemicals/materials industry is not doing really well at the moment and more or less reaching a cyclical bottom, we use a conservative forward EV/EBITDA of 8x (average of 2018's EV/EBITDA) and a forward EBITDA of $1.5 billion to arrive at an estimated target fair value of $50.50. This represents a 102% potential profit, at the minimum. Thus, we make our decision to go long at $25.00 for an estimated 3-5 years.

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. I have no business relationship with any company whose stock is mentioned in this article.