It's time to take a little detour after mainly discussing dividends this month. In this case, we will discuss AdvanSix Inc. (NYSE:ASIX), a small-cap chemical supplier based in New Jersey. In 2020, I started researching the company for private clients because of its agriculture exposure, which I will discuss in this article. The trigger was never pulled because we found a better agriculture-focused alternative. Yet, the stock accelerated from less than $10 to currently more than $45. Now, I will revisit the stock and initiate coverage for the first time on Seeking Alpha as the company is still way too cheap and a big beneficiary from re-shoring and sky-high chemical margins.
Now, the company has an incredibly healthy balance sheet, a high free cash flow yield, rebounding EBITDA, and a solid business model to provide sustainable income.
Let's start with the basics. What does AdvanSix do? Based in Parsippany, New Jersey, AdvanSix is a supplier of chemical products with a $1.31 billion market cap.
The company started trading in late-2016 when it became an independent company. In 2016, AdvanSix was spun off from industrial giant Honeywell International (HON). I bet that some people reading this are Honeywell shareholders who got shares in 2016.
ASIX generates is sales in four business segments, none of which brought in less than 19% of total sales in 2021. The company produces nylon, caprolactam (used in the production of nylon), chemical intermediates used in the production of adhesives, paints, coatings, and others, as well as ammonium sulfate, used as fertilizer, an herbicide, and for several industrial applications.
Especially in these times of broken supply chains and companies that move away from China (re-shoring) - which I explained in this article (I recommend you take a look) - it's a huge benefit that ASIX has three US-based factories.
Not only does the company produce its products in the United States, but it is also efficiently using its own supply chain to supply its own needs. For example, the phenol it produces in the Frankford Plant is (partially) used in its Hopewell Plant, which produces products that are also used in its Chesterfield Plant.
To quote the company:
Our integrated manufacturing process, scale and the quantity and range of our products make us one of the most reliable and efficient manufacturers in our industry. We consistently focus on and invest in improving production yields from our various manufacturing processes to build on our leading cost position. Our global logistics infrastructure enables a reliable intra-plant supply chain and consistent and timely delivery to our customers.
Moreover, while only 18% of 2021 sales were non-USA revenues, the company sees itself positioned to service rising export demand due to its freight and logistics capabilities and terminal locations.
Additionally, and this is very interesting, the company competes with companies like BASF Corp. and LANXESS, two German chemical powerhouses. These two companies - like all European producers - are currently suffering from sky-high energy prices. Even if Russia refrains from shutting off natural gas exports, ASIX will have a benefit in certain products (higher export demand) thanks to lower input costs (relatively speaking).
In other words, ASIX benefits from re-shoring of supply chains (long-term), high post-COVID demand for chemicals, suffering competition overseas due to high energy prices, and strong agriculture demand for its ammonium sulfate products.
As a result, the company is doing very well financially speaking. Last year, the company did $1.7 billion in sales, which allowed ASIX to do $255 million in EBITDA and $162 million in free cash flow.
In 1Q22, the company grew its sales by 27% compared to a strong 1Q21. This performance was caused by 29% higher sales prices, 2% higher sales thanks to M&A, and 4% lower volumes. In other words, strong pricing benefited this chemical company.
EBITDA surged by 79%. According to the company:
EBITDA increase driven primarily by improved market-based pricing, net of increased raw material costs, particularly natural gas and sulfur, partially offset by higher utilities cost driven by natural gas prices, and lower sales volume.
The EBITDA bridge below shows how powerful ASIX is when it comes to using its pricing power:
The graphs below show why ammonium sulfate turned into such a big tailwind. Between January 2021 and April 2022, prices of Corn Belt ammonium sulfate have risen from roughly $1,000 per ton (nitrogen content basis) to almost $3,600.
Thanks to this bull market, the sale of ammonium sulfate accounts for more than 30% of total company sales and more than 50% of total sales volume. 75% of the company's sales are domestic sales.
In this case, the company benefits from a number of tailwinds that are agriculture tailwinds in general. Global crop supply is under pressure due to low inventories, high fertilizer costs (caused by high energy prices), the ongoing war in Ukraine, high demand, and constrained logistics. ASIX benefits from all of these trends as it's a domestic producer with relatively short supply chains, and the ability to deliver more than just fertilizer.
As the TIKR graph above shows, the company aims to generate close to $400 million in EBITDA in 2022. This is expected to come with $215 million in free cash flow based on close to $99 in capital expenditures. Note that free cash flow is operating cash flow minus capital expenditures. It's cash a company can use to distribute a dividend, repurchase shares, or improve balance sheet health.
$215 million in expected free cash flow translates to a 16% free cash flow yield using the company's $1.31 billion market cap. In other words, if the company wanted, it could pay a 16% dividend or buy back 16% of its shares.
A 16% dividend yield isn't happening, but it shows how powerful the company's finances have become. On November 5, 2021, the company initiated a $0.125 quarterly dividend. This translates to $0.50 per share per year. That's a 1.07% yield using the current stock price. While there is room to hike the dividend, this is not supposed to be a dividend-focused article.
What I care most about is what the company spends excess cash on. In 1Q22, the company acquired U.S. Amines, a leading North American producer of high-value intermediates used in agrochemicals, pharmaceuticals, and other applications for a total price of $98 million. The company also repurchased more than 181 thousand shares for $38.6 billion.
It's fantastic to see that the company is now using the commodity bull market to improve its business, buying back shares, and initiating a dividend. Moreover, net debt is expected to be negative in 2023 (more cash than gross debt) as free cash flow is more than likely higher than any buyback or acquisition plans.
Besides that negative net debt is good news in general, the company will enter the next economic downturn in its industry - whenever that may be - with a much healthier balance sheet, which will reduce downside risk.
Moreover, it makes the valuation so much juicier.
ASIX has a $1.31 billion market cap. 2022 net debt is expected to be $65 million. The company also has close to $20 million in pension-related liabilities. All of this gives the company an enterprise value of $1,395 million.
This gives us an EV/EBITDA multiple of 3.5x using 2022E EBITDA of $400 million and 4.0x using 2023E EBITDA of $350 million. The decline is expected because analysts do not believe that the sky-high margin environment will last.
While it's hard to establish a "target" multiple, I would make the case that a company like ASIX should not trade below 6.0x EBITDA. This would give us a "fair" value of $2.1 billion using 2023 estimates. In other words, if the company is able to continue high EBITDA generation after margins come down a bit going in 2023, it could be trading at $75 per share.
Normally, I call this "Takeaway". Yet, in this case, I want to share my thoughts a bit more. What we're dealing with here is a small-cap company that has a lot more potential than the market is giving it credit for. The Honeywell spin-off ASIX has become a company with a terrific position in the North American chemical supply chain. After a devastating downtrend between 2018 and 2020 erased most of its market cap, the company is now finally in a position that allows it to erase its net debt, buy new companies to enhance its business model, and distribute cash using dividends and buybacks.
Right now, the company benefits from steady chemical demand (ex-agriculture), sky-high margins in its agriculture segment, strong free cash flow, falling debt, and a favorable valuation.
While I give the company a high fair value, this is by no means a call to go overweight ASIX. I have 95% of my money invested in dividend growth stocks and my main target is to discuss long-term investment opportunities. Trading opportunities should always be viewed as a "bonus" on the side. If I buy ASIX, it will be a very small position. It also means that if you're not a trader, don't start now. Only buy ASIX if you have a trading portfolio and if you're looking for exposure in the industry.
After all, ASIX remains a margin play. While I do expect a long-term uptrend due to supply chain re-shoring after the pandemic, that uptrend will likely be very volatile. Between 2018 and 2020, the company lost roughly 80% of its market cap due to lower demand and lower margins. A low-margin environment can come back in the future. While the company is now in a much better position thanks to a healthier balance sheet, it will more than likely cause damage again.
Moreover, earlier this year, the stock briefly dropped below $35. It rebounded, but it goes to show what kind of volatility investors will be exposed to.
So, long story short, I'm bullish on ASIX. The company is in a good spot, and I like what management is doing with the company. If you want to buy it as a trade, try to get in as close to $40 as possible. At that point, the mid-term risk/reward is really good.
(Dis)agree? Let me know in the comments!
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.