Celanese: 2.6% Yield Backed By Copious FCF

Summary

• Economic uncertainty amid the trade war sent Celanese's 2019 sales plunging. Margins, net income, and cash flow were also impacted.
• Despite headwinds, Celanese delivered over $1 billion in free cash flow left after covering the capital expenditures.
• Given copious FCF, I reckon Celanese's dividend is relatively safe.
• On the negative side, the company is surely not immune to the repercussions of COVID-19.

A few high-quality, dividend-paying names were battered amid the recent coronavirus-fueled sell-off. Among them was Celanese Corporation (NYSE:CE), a global chemical and specialty materials company. After a ten-year history of dividend growth, the stock yields approximately 2.6%. In the article, I would like to assess its most recent financials and expound on why this cash flow machine might be among dividend stocks worth considering.

2019 was overshadowed by a revenue decline

Celanese Corporation presented its Q4 and 2019 results on January 30. Though pundits have surely factored persistent weakness in the company’s end-markets in the net profit and sales estimates, the Q4 top and bottom lines still did not live up to Wall Street’s expectations. Both GAAP and adjusted EPS, which is purified from irregular items, were below analysts’ targets.

The company’s segments Engineered Materials, Acetate Tow, and Acetyl Chain were all afflicted and delivered bleak net sales and operating income.

1. Engineered Materials, Celanese’s flagship division, which produces and sells such materials as polyoxymethylene, thermoplastic polyesters, nylon, etc., experienced an 8% sales drop. Adjusted earnings before interest & tax dived 11%.
2. Acetate Tow that produces and sells acetate flake and tow mostly for cigarette filters was less afflicted and ended 2019 with a 2% revenue decline. Adjusted EBIT changed only marginally.
3. Acetyl Chain, the second-largest contributor to the consolidated top line, faced the steepest decline compared to other divisions; its net sales contracted by more than 16%. One of the culprits of the revenue slump was the acetic acid price in China, which dropped by approximately 40% year over year.

The disappointing performance was caused by headwinds that the U.S.-China trade confrontation had spawned. CE’s results are inextricably intertwined with the pace of the global economy, as the corporation addresses a plethora of end-markets from automotive and industrial to medical and pharmaceuticals; so “inconsistent consumer activity” cited by the CEO together with the price and volume effects amid “broad industry destocking” mentioned on the first page of the earnings release led to an 11.5% net sales decline year over year.

It is worth noting that operating profitability was also impacted by a few one-off charges like asset impairments (related to the Ocotlán plant closure), restructuring, and costs related to European Commission investigation. As it was detailed in Note 18 (see page 107 of the 2019 Form 10-K), other net charges (gains) amounted to $(203) million for the year.

To sum up, with all regular and irregular costs, interest, and taxes factored in, diluted GAAP EPS crept 23.3% down to $6.84 despite the positive effect of the buyback program on per-share data. Adjusted EPS was $9.53 for the year, down 13.4%.

Cash flow and capital allocation

While the top line and margins were under pressure, net operating cash flow also edged lower but positive working capital change, thanks to a $165 million decrease in trade receivables, buttressed it to some extent. As a result, 2019 net CFFO was $1.45 billion, only 6.7% lower than a year ago and 81% higher than in 2017. I also like its 23% operating cash flow margin that signals both GAAP and adjusted net earnings have high quality.

In 2019, cash allocated to capital expenditures equaled $370 million, above the 2018 level, as the global acetic acid reconfiguration project required funds. Still, capex was only 5.9% of revenue. Celanese was also not especially active on the M&A front, as it spent only $91 million on acquisitions. So, with all investing activities factored in, the company’s inorganic free cash flow hit $961 million. FCF computed as the difference between net CFFO and capex was even higher and stood at $1.08 billion.

The chart below illustrates how CE's cash flow had evolved during the 2010s and how its shareholder rewards had been covered.

All figures were calculated by the author using raw data from Seeking Alpha

Dividends had always been excessively covered by organic FCF; in 2018 and 2019, the coverage ratio approached 4.4x and 3.6x, respectively.

However, the company overspent its 2019 free cash flow, as it covered total rewards only 0.8x; the silver lining is that a massive stock repurchase program resulted in reduced share count, and in the future, CE will need less cash to cover dividend payments.

31% ROE is the tip of the iceberg

Celanese’s capital efficiency, as one of the issues dividend investors should keep an eye on, deserves deeper inspection. When I was doing my regular quick stock research, I immediately noticed an astounding 31% ROE that CE delivered last year, especially given the challenges the company coped with. While I was impressed, my first guess was that the overleveraged balance sheet was behind this stellar result. And unfortunately, I was right.

Unlike many bottom line-focused investors, I am highly skeptical of Return on Equity in cases when a company bears sizeable debt. Celanese represents a perfect case when earnings yield used together with ROE are irrelevant, as these metrics ignore total debt of $3.8 billion, which, by the way, is even higher than shareholder equity. Though Celanese is far less leveraged than another chemical industry heavyweight The Chemours Company (CC), a 131% Debt/Equity does not look like a matter that can be easily ignored.

So, $0.313 in net earnings generated per dollar of average 2019 shareholder equity is a startling result, but Cash Return on Total Capital and Cash Return on Capital Employed tell a slightly different story.

All figures were calculated by the author using raw data from Seeking Alpha

For instance, CROTC was 21.6% (close to a ten-year zenith), while CROE hit a phenomenal 19%. So, I was a bit skeptical when I discovered CE’s above 30% ROE but when I did more thorough research, I was positively impressed by its close and above 20% returns on total capital and capital employed, which indicate the company was exceptionally efficient in 2019 despite the bleak economic environment.

Financial position

As I have already mentioned above, Celanese has a hefty debt on the balance sheet, mostly comprised of both euro and dollar-denominated senior unsecured notes with different maturities. CE also sat on $446 million of cash at year-end 2019. But though 131% Debt/Equity is somewhat worrisome, I estimate its Net debt/Operating EBITDA to equal 1.85x, which is below a 2x benchmark I consider safe.

Briefly on valuation

As analysts expect Celanese’s 2020 EBITDA to edge lower, the Forward EV/EBITDA ratio is above the same multiple based on the 2019 data; as of March 4, it stands at 8.1x. Given the Materials sector median is just 7.5x, the stock does not look extremely cheap.

Conclusion

Tumbling stock prices amid the coronavirus sell-off create dividend opportunities. Given Celanese’s resilient cash flow, I believe its DPS is relatively safe. Analysts forecast its 2020 revenue to expand by 2.5%. If their estimates fail to materialize and 2020 sales contract, while net operating cash flow drops 50% (for instance, because of working capital issues), assuming unchanged capex, CE will still have close to $357 million in free cash flow, adequate to cover $300 million in dividends.

Yet it is tough to precisely quantify the ramifications of the coronavirus, as the situation is fluid and is evolving rapidly. The magnitude of repercussions is still not clear. The uncertainty is elevated and approaching the extremes. Central banks signal they are ready to step in and reanimate economic activity and mitigate the debilitating effects. On March 3, the Federal Reserve cut the Federal Funds rate target range by a record fifty basis points, sending an unambiguous message to investor community: though the U.S. economy is on a firm footing, the economic toll of the coronavirus can be material.

But I reckon monetary stimuli will have a temporary effect. At the same time, ultra-low interest rates will take a toll on the bank system and send banks' profits plunging, thus depressing their market values and dragging the S&P 500 down.

The markets need a clear message that the virus is contained and cases have plateaued. Now, no one can say precisely when this inflection point can be reached. To sum up, my sentiment on CE is neutral.

Analyst’s 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.