Methanex: Excellent Management, But Now Is Not The Time To Buy

Summary

• Methanex buys natural gas, converts it to methanol, and operates in markets across the globe.
• Supply/demand forecasts for methanol look bearish for MEOH shares in the short term.
• Supply/demand forecasts for natural gas look neutral for MEOH shares in the short term.
• MEOH has an excellent management, as evidenced by its capital allocation patterns in its financial data.
• Not a buy in the current market environment, but definitely worth scooping up some shares once methanol prices bottom out.

Methanex’s Business & Operations

Methanex (NASDAQ:MEOH) converts natural gas, or methane (CH₄), to methanol (CH₃OH). First, where are Methanex’s facilities? They are scattered all over the globe: Trinidad, New Zealand, Egypt, Canada, the United States, and Chile. Methanex is a global operation – sourcing materials globally, and marketing methanol globally.

What is methanol used for? The largest uses are for the production of methyl methacrylate (plastic), gasoline blending, and olefin (unsaturated hydrocarbon) production. Natural gas is the major process input, while methanol is the process output. We can therefore conceptually understand Methanex’s operating income as thus:

Operating Income = Methanol Revenue – Natural Gas Input Cost – Overhead

Whether investors should be bullish about Methanex, therefore, depends on three components:

1. Methanol Revenue (described below)
2. Natural Gas Input Cost (described below)
3. Overhead

This article can only provide a cursory glance at how to price MEOH shares – these markets are vast and highly complex. Needless to say, the forecast here is purely the author’s own speculation based on the data researched here.

Methanol Price & Supply / Demand

Source: Oct 2019 Investor Presentation

The main takeaway here is that Methanex expects global demand growth to decelerate, with 2019 being an inflection point. Reading the S&P Global 2019 H2 Outlook, we can take away these following key points about recent developments:

• Russian production has recently ramped up, and Europe has been unable to absorb the excess supply. This meant that excess production was marketed to East Asia and Southeast Asia.
• This has caused Chinese methanol prices to fall to $250/mt.
• Additionally, Kimiaye Pars and Bushehr Petrochemical in Iran are starting production at a 1.65Mt/year facility.
• Overall, prices are expected to be pressured due to an increase in methanol supply.

How can we synthesize this information? In the near term, it appears that world methanol demand growth is decelerating at the same time that new production facilities are coming online. This is a bearish signal for methanol prices.

Natural Gas Price & Supply / Demand

This is a truly monstrous topic to cover – I’ll simply summarize the main points from the IEA’s 2019 market report (Market Report Series: Gas 2019 - Analysis - IEA)

• Natural gas prices have historically been lower in North America (Henry Hub) than they have been in Europe and Asia.
• Natural gas markets have historically been mostly separated from each other due to the difficulty of transporting natural gas.
• However, the liquid natural gas (LNG) trade has been causing world prices to converge. This makes it easier to prognosticate about natural gas prices. (Whew!)
• Most production growth comes from the USA and China. However, China and South Asia are unable to satisfy its own demand, so most LNG exports from the US, Russia, and Australia satisfy the Asian markets.
• Much of this appears to be neutral for world natural gas prices. Additionally, the report did not indicate any major supply / demand imbalances.

Regarding world demand: Reading a CNBC article from June 2019 - there is one big key point: Global demand grew 4.8% in 2018, but demand growth is expected to average 1.6% per year through 2024. This is a slightly bearish signal for world natural gas prices.

Overall, putting together a bearish signal for methanol prices and a neutral signal for natural gas prices, we might predict a compression in gross margins in MEOH in the near future. Therefore, we should be bearish on MEOH share prices.

Methanex’s Financial Statements

Sifting through SeekingAlpha’s Key Data for MEOH, I will put together a select few rows to demonstrate Methanex’s financial straengths.

All figures in millions USD	Operating Cash Flow	Net Debt Issued / (Repaid)	Common Stock Net Issuance / (Repurchase)	(Dividends Paid)	(Capital Expenditure)
2009	110	136	0	(57)	(345)
2010	183	25	9	(57)	(146)
2011	480	(53)	11	(62)	(158)
2012	416	354	19	(68)	(188)
2013	586	(30)	39	(75)	(588)
2014	801	551	(241)	(90)	(658)
2015	297	(194)	(142)	(97)	(425)
2016	227	12	2	(99)	(100)
2017	780	(64)	(283)	(102)	(103)
2018	980	(56)	(444)	(106)	(245)
2019	619	585	(131)	(106)	(297)

Bear in mind that Methanex is a Canadian company, so these USD figures are 100% representative of their financial results, due to forex fluctuations. MEOH is a cyclical business, so rather our goal is to examine management’s capital allocation habits.

Here are the main takeaways:

• Dividends were always more than covered by operating cash flow.
• Years with high operating cash flows (2013, 2014, 2017, 2018, 2019) saw a significant return of capital through share buybacks.
• Years with low operating cash flows (2009, 2010, 2016) saw discipline: low capital expenditures and negligible changes in share count.

This paints a picture of a company that:

• Is highly capable of managing its cash flows
• Is capable of (mostly) organically funded growth
• Is able to cover dividends with operating cash flow
• Understands how to deal with lean and fat years

The overall verdict? MEOH is a very solidly run cyclical business, with a management that understands how to manage cash flows through the methanol market cycle. However, I believe that there are downward pressures on its gross margins, hence MEOH is not a buy at current price levels.

When methanol prices are low, though, is the best time to pounce!

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.