Fahroni
Investment Thesis
The Canadian company Methanex (NASDAQ:MEOH) is a mid-cap producer and supplier of methanol to major international markets in Asia Pacific, North America, Europe, and South America. In addition to having methanol production facilities in several countries, the company owns the world’s largest methanol ocean tanker fleet as well as terminal capacity in all major international markets.
With its low-cost structure, good governance, and favorable debt maturities, Methanex is a good candidate as a long-term hold, although the current share price of $44 is not a bargain unless speculating on methanol pricing.
Methanol And Its Pricing
Methanol is a clear liquid commodity chemical that is primarily produced from natural gas or coal. It is used to produce a wide variety of chemical derivatives that are used in industrial and consumer products, with its derivatives including formaldehyde and acetic acid. Several other applications, including energy-related and plastic-related, are described in more detail below:
Methanex Investor Presentation
As Methanex is a commodity producer, the fluctuations in methanol pricing significantly affect its profitability. In recent years there was a very favorable commodity pricing environment in which realized prices for methanol sales were above $390 per tonne:
Methanex 2022 Annual Report
Prior to this favorable pricing environment, pandemic-related issues contributed to a low realized price in 2020. However, even before pandemic issues, the realized prices for methanol had averaged below $300 per tonne:
Methanex 2020 Annual Report
On the most recent data that was found on the Methanex earnings release for Q3 2023, realized prices have moved back closer to the $300 per tonne level:
Methanex Q3 2023 Earnings Release
The CEO also provided additional commentary on the Q3 earnings call, which guides pricing to be continuing in a similar range through most of 2023's Q4:
Based on our October and November posted prices, we estimate our global average realized price to be approximately $310 to $320 per metric tonne for these two months.
Supply-Side Risk
Since the production of methanol is done in a highly competitive commodity industry, future pricing for the chemical will depend on both the rate that industry expands supply and the strength of global demand.
Capacity is expected to expand at Methanex itself, where the last stages of construction are being done to complete its third plant in Louisiana, with a planned annual capacity of 1.8 million tonnes. The plant is expected to be online for actual production towards the end of Q4 2023. For reference, this 1.8 million tonne plant compares with Methanex-produced methanol sales of 6.1 million tonnes in 2022 and 6.2 million tonnes in 2021. It is hoped that the location in Louisiana and its abundant availability of natural gas will provide the plant with a lower cost structure than existing supplies.
Geismar 3 Methanol Plant Construction Progress (Methanex Project Page)
Other significant ongoing projects in Malaysia, China, and Iran were mentioned in management comments as potentially providing an additional supply of methanol in the near term:
In Iran, we believe there are two plants under construction, one of which may be close to completion. The completion of major projects as well as ongoing plant operating rates in Iran continue to be uncertain and challenged due to the impact of ongoing sanctions, plant technical issues as well as ongoing natural gas constraints (particularly in the winter months). In Malaysia, a 1.8 million tonne plant is under construction with a scheduled start up in 2024. In China, there are planned capacity additions over the near-to-medium term which we expect will be somewhat offset by the closure of some small-scale, inefficient and older plants
With 2023 realized rates already significantly lower than during the past couple years, the increased production capacity provided by these new plants could contribute to a further reduction in realized rates and could amplify unfavorable effects caused by any potential negative macro-events in 2024.
Cost Structure, Governance, And Balanced Debt Maturities Mitigate Some Risk
Despite having the complexity of operating in several countries, maintaining leadership in the production of methanol through several production plants, and owning the largest methanol ocean tanker fleet, Methanex seems to have avoided creating an expensive corporate bureaucracy whose overhead soaks up its margin. Administrative cost as a percentage of revenue has consistently tracked in the low single digits. This is even after including employee stock compensation, which is primarily responsible for the occasional spikes in the below chart I compiled from the Methanex annual reports:
Author Compilation from Annual Reports
However impressive it is for a company to be able to organize such an efficient overhead to manage international operations of Methanex's complexity, I find the disciplined approach taken by the management team in their capital allocation to be even more impressive. Instead of seeing typical small-cap and mid-cap agency problems with investing the cash generated into middle managers and/or pet projects, cash seems to be consistently returned to the shareholder:
Methanex Investor Presentation
The lack of appearing to have obvious agency issues in the company’s capital allocation decisions may have to do with genuinely following their share ownership requirements for board members and executive officers:
Methanex Website
Finally, the long-term debt obligations of the company have been secured at what are now quite favorable terms. Maturity dates for the debt are conservatively staggered and help to limit the risk of any near-term liquidity issue:
Methanex Q3 2023 Earnings Release
Fair-Value Calculation
As mentioned earlier, I don't view the market price of $44 as unfairly valuing equity shares of Methanex. As a pure-play commodity producer, its future profitability will be dependent on the future pricing of methanol. However, I will perform a calculation of fair value below.
Earnings from Methanex can be expected to continue the high variability that it has demonstrated in prior years. For the purposes of a quick valuation, I adjusted operating earnings to exclude the net income of Methanex subsidiaries that have non-controlling interests. Also, the company has a 63.1% interest in a methanol facility that is accounted for under the equity method. It's not clear to me why a majority-owned subsidiary would use the equity method, so I have also reclassified the earnings of that associated entity to be included in operating income.
Author Calculation from Methanex Annual Reports
Given that the average realized price per tonne during the first three quarters of 2023 has been $337 and has declined below that in the fourth quarter, near-term future earnings can likely be assumed to currently be in the lower range of the past five years (excluding 2020 due to the unique circumstances). If we take the average of the above of $567 million as a sufficient approximation of forward cyclical pricing/results, then we will assume a forward average EBIT at $567 million. If we compare this to the below EV/EBIT multiples of companies listed as peers (in the sense of being involved in production of chemicals, not peers in production of methanol), then we see multiples generally trading within the 10-13 range over the past year:
Seeking Alpha Peers List
With net debt from the latest current earnings release at approximately $3.22 billion, relative equity values for Methanex within these multiples approximate $2.45-3.90 billion. Given the 67.4 million shares outstanding, this corresponds to share prices of $36.35 - $61.58. At the current price of $44, shares thus appear to trade at prices that appear relatively fair.
I would caution that the above is a relative approximation of fair value intended only to support the statement that current equity prices are not trading at particularly discounted prices despite near-term headwinds. The company is in a cyclical business with limited pricing power, meaning the supply/demand fundamentals of methanol will determine the company's profitability and value in the future.
Conclusion
My opinion is that Methanex has a competitive advantage given the efficiency in how it has organized its complex operations cost-effectively. The disciplined way that excess cash has been returned to shareholders also gives me confidence in the management team’s ability to allocate capital.
Despite some of the above praise, I would not recommend adding additional shares at the current price of $44 unless desiring to speculate on methanol demand in 2024. As a pure-play in a cyclical commodity business, I believe the current $44 share price does not have a large enough margin of error to offset the uncertain supply/demand outlined. I feel my rating of “hold” is appropriate and would look to re-evaluate this rating upon either a dip in share price or a better supply/demand outlook.
