Chemours: The Upside Is Offset By The Risk

Summary

• Chemours Company is a company I've gotten some requests to write on, due to its legacy from the DuPont company.
• In this article, we'll look at whether this business could be of interest to you for investing long-term.
• My view on the company is that there are some not-inconsiderable challenges to the longer-term thesis.
• Learn which ones here.

JStuij/iStock via Getty Images

In this article, we'll look at the Chemours Company (NYSE:CC). The company is essentially what remains after DuPont (DD) decided to spin off its performance chemical business into a separate company, and this action was completed in mid-2015.

This means that for 5-6 years, this company has now traded as a separate entity.

Let's see how things look at the present.

(Source: Chemours)

The Chemours Company - What does the company do?

The company is a global provider of what they call "performance chemicals", which are input commodities for end-products and processes in a variety of industries. This does, of course, not tell us much.

The company's operations can be summarized in four reportable segments, following an FY20 bifurcation of segments. These are:

• Titanium Technologies, where the company delivers TiO2 pigment, where CC is one of the largest producers in the world of TiO2. TiO2, for those of you who aren't well-versed in chemistry, is Titanium Dioxide or Titania, which is a naturally-occurring mineral that's used in a variety of applications, including but not limited to cosmetics, enamels, industrial applications, paint, highly resistant coatings, nanotech, inks, consumer products, and food coloring. For me as a (part-time) oil painter, Titanium dioxide is the pigment used in the most common whites, whereas earlier we would use Lead Carbonate, a far more dangerous form of white (though I still prefer it in some cases!)
• Thermal & Specialized Solutions sees the company as a market leader of refrigerant, propellants, blowing agents, and specialized solvents. The company provides Freon and similar technologies and commodities for refrigeration and similar segments.
• Advanced Performance Materials, meanwhile, provides high-end polymers and highly advanced chemicals and materials exhibiting extreme properties, such as complete chemical inertness, thermal stability, low friction, corrosion resistance, and unique dielectric properties. Products include primarily resins, coatings, and other specialty products, and customers are from all over.
• Chemical Solutions produces industrial chemicals, including being one of the largest NA producers of sodium cyanide as well as other industrial chemicals. Customers are mainly found in North America.

Now, the company has competition in almost every segment, including peers such as INEOS AG, Tronox, Honeywell (HON), Daikin Industries, 3M (MMM), Cyanco Corp, and many others, depending on what segment you're looking at.

On the fundamental face of it, Chemours does not look all that good.

Let's begin with company credit rating, which is unfortunately only a BB-, meaning junk and "junkier". The company's earnings cannot be said to show any sort of stability, but rather exhibit the cyclicality and volatility typically associated with commodity producers, while not exactly giving investors an above-average yield at 3.35%.

(Source: F.A.S.T graphs)

This seasonality and volatility is expressed in the company's share price, where investors since 2015 have been treated generally to market-beating returns, but with a lot of volatility in between - and frankly, would have been better off selling at overvaluation.

Company sales are made through specialized sales teams across the world with deep expertise in their respective field, and sales are primarily made directly to end customers in industrial quantities of products. The company does operate a distributor network for specific product lines and geographies, and sales are made either through one-time buys/spot buys or long-term contracts.

Dividend growth has been impressive at double-digit CAGR over the past 5 years, and the company currently pays out less than 50%, even with 2020 results.

The company was heavily impacted by COVID-19 and saw a half a billion USD drop in sales, as well as significant EPS declines. The company also comes in at a relatively high debt position, around 78% long-term net debt/cap.

End markets and company segments enjoy a strong future due to appeal for the company's products, that much is clear.

(Source: Chemours)

The company's products are, furthermore, used by virtually every segment of customers on the planet, making for an appealing sort of fundamentals. The company is also, looking at the guidance from 2020 for 2021, outperforming its original guidance by quite a bit.

However, issues come in the form of litigation - which we'll take a deeper look at in the next segment.

Let's look at the recent results here.

Chemours Company - How has the company been doing?

The latest results call for a forecasted full-year EPS of well over $4, almost 25% over the original guidance. Chemours managed the 5th consecutive quarter of sequential sales growth, but because of COVID-19, this should be a given, not an argument for fundamental investability.

The company, as of 3Q21, further increases overall guidance for the year, and despite a high LT debt/cap, has managed to reduce its debt to fairly appealing levels, while also holding available cash and revolver of close to $2B.

(Source: Chemours)

So while the credit rating is frankly poor, the company is moving in the right direction, with all segments performing well in both sales and profits. Every company segment reported strong net sales growth, with Titanium and Advanced performance rebounding at nearly 50% sales growth YoY. Here is the latest guidance from the company.

(Source: Chemours)

However, the main problem with the company - both recent and historical - isn't its results, but the controversies surrounding its volumes of litigation related to its chemicals. This is also the reason, in part, for the company's abysmal credit rating. The company suffers mainly from PFAS/PFOA and HFO issues and their regulation and involvement in these chemicals - and these risks are high enough that you can actually find documentaries featuring Chemours, though these documentaries are of coursed bias.

(Source: Chemours 10-K)

Aside from Fayetteville, the company is also under scrutiny in the Netherlands due to the use of PFOA during the pre-spinoff period in 2008. In short, a big part of the risk here is not only what the company is doing, but what it has done as part of the pre-spinoff DuPont.

The ESG risks and litigation risks for the company are, in fact, too complex to go into in an article like this, and it would be highly speculative to guess at the outcome of these court cases, as lawsuits in multiple nations are currently ongoing. What can be said, and what I see in the company's responses, is that the management team is responding well - but that long-term risk remains here. The reason is that the company is unlikely to shift away from the chemicals that are causing the legal issues, due to significantly lower barriers to enter in competing chemical segments.

In terms of HFO/HFC, Chemours is the largest global pollutant by far of HFC-23, a gas that is thousands of times more polluting than Co2 and is an inevitable byproduct of Freon production. While the company is already addressing this with its Opteon products, it nonetheless remains a not-inconsiderable risk to the company, both historically as well as going forward.

It isn't as though the company is out in the cold. Pre-Spinoff partners DuPont (DD) and Corteva (CTVA) have already agreed to assume around half of the remediation and legal costs for any PFOA liabilities until 2041. That should take some of the weight off Chemours, but only for liabilities starting at $4B. Any liability below $4B, Chemours is fully liable.

You may think that surely the risks must be over or known at this point - new risks cannot arrive. This is unfortunately false. The more investigations are made into PFAS, like GenX, the higher risk we'll see continued litigation here, including but not limited to personal injury, cleanup, fines, and further preventative costs.

Want to see how this sort of thing can hurt a company, even though it should be able to financially handle fines? Look at Bayer (OTCPK:BAYZF).

In short, there is a lot of litigious uncertainty to Chemours - and that is not likely to go away. Investors need to be aware that the company likely will continue to trade in a volatile manner due to these uncertainties, and that such uncertainties need to be taken into consideration prior to any investment decision.

Let's look at valuation.

Chemours - What is the valuation?

The valuation for Chemours is both good and bad. Trading at 7.52X to P/E, Chemours cannot be said to be trading at expensive multiples. However, at the same time, the company is typically traded at average multiples below 9.7X, precluding any assumption that a fair-value 15X P/E is something that could be achieved long-term. At least not under current circumstances.

Given the high litigation risks Chemours suffers from, I'm not surprised at the discount the market is attributing to this company.

(Source: F.A.S.T graphs)

Before saying that this is cheap, consider that less than 3 years ago the company traded at valuations of below 4X. This puts a different spin on the current multiple.

Accounting for expected EPS growth and a 9.7X forward P/E based on a 3-year average EPS growth of 16% gives us a potential RoR of 28% annually or almost 68% in 3 years. However, this comes with a very large failure rate in terms of forecast. Analysts haven't yet learned to forecast this company with any sort of accuracy, and they either miss positively or negatively.

(Source: F.A.S.T Graphs)

This makes it more of a guessing game than anything else. Also, consider what happens to the company's valuation and share price when earnings drop or during earnings misses, as we saw in 2019 - share price plummeting to very low levels.

In short, even though the company looks attractively priced here, all you need to is look at historical performance to see how instability or drops in earnings could affect performance here. Analysts do consider the company undervalued here (Source: S&P Global), but I personally wouldn't give this much credence based on analyst target accuracy.

(Source: Tikr.com)

These analysts have, at times, and over years, the tendency to overvalue this company grossly, only to then undervalue it during upward momentum.

However, none of that even comes close to the fundamental valuation problem with Chemours, which to me is this:

You're investing in a company with heavy legal risks when there are conservative, A-rated chemical producers with a much higher yield, at higher levels of outperformance at similar, conservative forward targets.

This sector is a tricky investment - and investing in a company with a BB- rating, albeit good fundamentals, and a yield that's below what you could get on the market today is not a particularly good idea, to my mind. While I cannot point to any one concrete risk that would bring Chemours low, the simple fact is that peers in diversified and specialty chemicals across the globe trade at more appealing valuations.

You could invest here and garner returns of 8-9% even on a 6-7X forward P/E. In that scenario, you are "safe" - but the question is how safe you can be with this company's fundamental issues hounding it, that is unlikely to disappear in the near term. While it could be considered speculative to base an investment thesis off risks as unknown as these, I consider the risk/reward ratio to be negatively asymmetrical in this case. The company's historical earnings are too "all over the place" to really consider these targets indicate for the long term, ranging from negative $0.32 to a profit of $5.45/share (Source: S&P Global)

In the case of similar companies with similar risks, we're looking at high-IG credit ratings for those companies, as well as larger market caps. The fact that CC is all by itself handling liabilities up to $4B is another risk to that pile.

Frankly, given the market opportunities we see today, I'd want a far cheaper valuation even than the one we currently see before going into this BB- investment.

I'd go in at a P/E closer to 5.5X average, or a share price of $20/share. At that point, this company would yield enough on a peer comparison, as well as be cheap enough in relation to historical lows to justify the risk I'm taking here. To those saying that I'm underestimating the value of forecasted earnings and cash flows, I point to the fact that these earnings or cash flows, based on historical trends, are not indicative and that they suffer from legal risks that on a relational basis makes Bayer's Roundup risk seem very small.

Chemours is a "HOLD" here - even if it cannot be called "expensive".

Thesis

My current thesis for Chemours Company is the following:

• The company is fundamentally appealing due to its chemical portfolio but is hounded by potential legal issues - both future and historical, as well as an unappealing liability profile.
• This combined with an upside that is less than its peers, a lower credit rating, a lower yield, and less dividend history, makes this one an unappealing prospect under current circumstances. I see no catalysts that would make this a superior investment to other chemical majors.
• I give it a "HOLD" and "neutral" rating, with an overall price target of $20, well below the current analyst average, but considered fair on a peer and risk/reward comparison.

Remember, I'm all about :

1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

This process has allowed me to triple my net worth in less than 7 years - and that is all I intend to continue doing (even if I don't expect the same rates of return for the next few years).

If you're interested in significantly higher returns, then I'm probably not for you. If you're interested in 10% yields, I'm not for you either.

If you however want to grow your money conservatively, safely, and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.

Chemours Company is currently a "HOLD".

Thank you for reading.

Disclosure: I/we have a beneficial long position in the shares of BAYZF, HON, MMM either through stock ownership, options, or other derivatives. 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.