Note: this article was written in September, and while I have attempted to update all time-specific data like references to stock prices, data should not be viewed as exact, but it's enough to establish the general point. Additionally, some of the data referenced here is from the Q2 report; Celanese reported Q3 recently, see transcript here. As always, please do your own due diligence before investing in any security.
Celanese (NYSE:CE) may just be one of the biggest corporations you've never heard of. Indeed, the integrated chemicals and specialty materials company weighs in at #368 on the Fortune 500 list, sporting a tick over $6.7B in TTM revenue and a very similar $6.6B market cap. Yet a quick check here on Seeking Alpha reveals that investment coverage on the company is limited at best. Prior to an August 26th article by Alan Brochstein discussing Celanese's TCX technology in the context of the drought, Seeking Alpha had seen only four Celanese focus articles in the past two years - three of which were earnings previews or recaps! This lack of coverage is one of the reasons I think Celanese could be set to significantly outperform.
The Bull Thesis: TCX Will (At Least) Double EBITDA
I strongly believe that the best investing opportunities are hidden in plain sight. Celanese offers one such opportunity. Given the company's size, the lack of coverage astounded me. Perhaps most commentators lack the chemical knowledge to fully appreciate the opportunity present?
The core of my bull thesis revolves around a specific technology: Celanese TCX. Celanese TCX is a technology that can convert various hydrocarbons (ex. coal or natural gas) into ethanol. Celanese is keeping the exact details of how the process works close to the vest, for obvious reasons. A 2009 article in Chemical & Engineering News suggests it might involve a hydrogenation reaction catalyzed by cobalt/palladium or platinum/tin. However it works, though, the possibilities are exciting.
Why is it exciting? TCX would be huge for low-cost fuel, as demonstrated by the company in a recent presentation:
In the C&EN article quoted above, Steven M. Sterin, company CFO, estimated that ethanol for industrial use would generate $1B in revenue by 2016, which would represent a 15% addition to current revenue. Given that Celanese estimates the division could generate 30% EBITDA margins, this represents a 20% increase in company-wide EBITDA - and that's just for the industrial ethanol applications of TCX. Assuming an extremely conservative 20% market share and 10% EBITDA margin, TCX applied to fuel ethanol would be worth $1B in additional EBITDA. This, added to the EBITDA from industrial ethanol, would be equal to the entire company's EBITDA for 2011. In short, TCX technology could double earnings, conservatively speaking. This does not even account for earnings growth in other segments of the company.
Background: Humans' Favorite Hydrocarbon
To fully understand TCX, you have to understand ethanol. And to fully understand ethanol, you have to understand the macro energy situation that the world is faced with.
Let's start with the macro energy situation, which really isn't that complicated. We're currently in the middle of a population explosion, which, in emerging countries, shows little sign of slowing. While this in and of itself would drastically increase energy use, the fact that literally billions of people will be coming out of poverty and starting to use proportionately more energy per capita only exacerbates the situation. Short story: we will require increasing amounts of energy in the coming years.
While the scientific merits of peak oil are hotly debated, there are several reasons that oil is unlike to continue its monopoly as fuel du jour. First, from a purely quantitative perspective, supply and demand would seem to dictate that oil may not always be the most economical fuel. Let's do some back of the envelope calculations here - feel free to correct or improve upon these; they're just for overview purposes.
BP's comprehensive 2011 Statistical Review of World Energy provides the following numbers on proven energy reserves:
- Total proven world oil reserves: 1.38 trillion barrels
- Total proven world natural gas reserves: 6,608 trillion cubic feet
- Total proven world coal reserves: 861B tons
Plugging in the generally accepted thermal energy conversions, we can analyze these reserves in terms of how much energy they can provide when burned in a perfect engine.
The exact numbers aren't particularly important; the key takeaway is that there's a lot of energy to be had from various sources. As alluded to before, basic supply and demand would seem to dictate that if only oil was used, at some point, coal and natural gas would begin to become extremely attractive on a cost basis. That is, of course, if coal and natural gas could be efficiently converted to easily-consumed fuels. That's an important point; keep it in mind moving forward.
Now let's move on to ethanol, which gained notoriety for being subsidized through tax incentives and more. (As it turns out, ethanol is the common name for ethyl alcohol, which is the same sort of alcohol served in bars everywhere. But most people don't know that.) Ethanol is fairly easy to burn, and while it may cause damage to some engines, it's certainly a lot more "accessible" form of energy than a hunk of coal.
Because ethanol has desirable properties as a fuel, well-intentioned but scientifically uninformed government officials decided to mandate that we include it in our fuel supply. The vision was that eventually, America would be energy-independent, filling our vehicles with ethanol distilled from corn grown in purple fields from sea to shining sea. Unfortunately, the sea to shining sea part turns out to be somewhat literal. As pointed out by a 2006 Competitive Enterprise Institute study, fueling the world with biofuels like corn ethanol would require planting crops in the Sahara desert and the Siberian tundra:
Projected world power requirements in 2052 will rise to a total of 22 to 42 trillion watt-hours, say the earlier cited Science authors. Producing this from crops could require as much as 80 percent of the Earth's total land area-especially if they are grown without such fossil-energy products as nitrogen fertilizer and pesticides. Supposedly, we'd be energy-cropping the Gobi Desert, the Amazon River basin, and northern Siberia.
While I certainly hope biofuels play a role in our future, it's pretty clear that in the near-term, the technology is nowhere near advanced enough for us to end our dependence on fossil fuels. This, of course, ignores other negative ramifications like the fact that corn-based ethanol drives up food prices and, until recently, actually had a net negative energy balance, meaning it took more energy to produce a gallon of ethanol than you could get by burning the aforementioned gallon of ethanol. Point being, biofuels aren't going to save us anytime soon.
This brings us back to the original dilemma - what to do for fuel? The original quantitative supply-and-demand argument I presented is actually a bit simplistic, and ignores the fact that certain parts of the globe are naturally rich in certain fuels. While OPEC may have oil, the United States has a natural gas glut, and plenty of areas are rich in coal and other forms of hydrocarbon stores. Again, a lay observer might wonder why natural gas can't be poured directly into a car engine, a question partially answered by a New York Times article titled Why One Gas Is Cheap And The Other Isn't:
The natural gas market, on the other hand, is not a global one. There is a limited trade in liquefied natural gas, which can be transported in tankers, but mostly natural gas must move in pipelines over land. Natural gas prices have been rising in Britain this year even as they have been falling in the United States.
Supply has soared in the United States because of increased production from hydraulic fracturing, but demand cannot change rapidly. Power plants that can burn natural gas or oil were shifted to gas long ago. Add in a relatively mild winter in the United States, which reduced demand, and there appears to have been a glut.
There are efforts being made to use more natural gas. Some fleet vehicles, like buses, already use natural gas, but that market is limited to vehicles that can return to their headquarters for refilling.
Essentially, using CNG/LNG for vehicles would require a concerted effort on the part of automakers, regulators, gas producers, and gas transporters. It's somewhat akin to the chicken-and-egg challenge faced by electric cars: nobody wants to build charging stations until people are buying electric cars, and nobody wants to buy electric cars when there aren't any charging stations. Changing our vehicles (and other things) to run on natural gas would be fairly difficult, and don't even get me started on the engineering issues faced by a vehicle attempting to run on chunks of Appalachian coal. Clearly, it would be helpful if these various energy sources (and others we may discover) could be easily converted into an easy-to-burn fuel that is already compatible with most of our machinery and vehicles.
Enter Celanese TCX
The process described above (easy conversion of various forms of hydrocarbons to easy-to-burn fuel) is the silver bullet of the energy world. That silver bullet has been developed, and it's called Celanese TCX. Below is an image from Celanese which is admittedly somewhat promotional, but nonetheless very exciting:
This is a lab scientist's dream. One process (or most likely, several) that allows you to use whatever energy source is easily and locally available and convert it into your desired end product - here, ethanol. Celanese plans to leverage this technology by setting up new plants or retrofitting old ones to use the technology to convert local hydrocarbon sources into ethanol. Celanese has constructed a facility in Clear Lake, Texas, and is retrofitting an integrated acetyl facility in Nanjing, China, which is expected to be online by next year. Celanese is also partnering with Pertamina, the Indonesian state-owned energy company, to develop synthetic ethanol projects in Indonesia. The long-term strategy is to build these plants in other countries like Australia that have high deposits of non-crude-oil hydrocarbons. Additionally, techniques to convert waste products into ethanol are currently under development as well.
Oh, and - "low cost" means "low cost." Currently, the production cost is roughly $1.50-$1.75/gallon using natural gas, which is (obviously) significantly lower than the price of traditional oil-derived gas. In fact, besides a short dip post-Lehman, that's lower than gas prices have been in the past 8 years.
While my bull thesis for Celanese is primarily based on the extensive potential of TCX, I believe at least a cursory overview of the company's other segments is worthwhile.
Acetyl Intermediates is the company's largest segment, providing chemical products for paint, adhesives, and construction products. As home starts pick up and demand for these end products subsequently increases, this segment should fare well domestically. Industrial Specialties is related and makes specialty chemicals.
Advanced Engineering Materials offers specialized polymers and plastics for a variety of industrial applications from conveyor belts to fuel systems. The company's expertise and specialized product portfolio should provide a fairly wide moat.
Finally, Consumer Specialties produces food additives including sweeteners and preservatives. These end-products have relatively inelastic demand that is in a long-term uptrend due to population growth, consequently, I see limited risk in this area.
While the focus of this article (Instablog, rather) is on TCX, I am pleased by the performance of the company's other segments and may post a more detailed analysis thereof in the future.
While the TCX story is certainly exciting, I'm not one to hop on overpriced story stocks. Luckily, there is little to no hype surrounding TCX, even though (in my opinion) there should be, and consequently, Celanese can be picked up at a downright bargain price. Celanese looks fairly cheap in absolute terms with a P/E ratio hovering around 10. Given the macro uncertainty and the relative unpopularity of the materials/chemicals sector, I believe it is prudent to put this into industry context. Comparing the valuations of individual chemical companies is somewhat difficult. While it's easy for the casual observer to generalize all "chemical companies" into a little box, synthesis and processing difficulty varies widely depending on what compounds you're after. Nonetheless, I believe comparing Celanese to a few "peers" demonstrates that it is, on a relative basis, still pretty cheap. As demonstrated by the two charts below, it trades at a significantly lower P/E multiple.
For what it's worth, Celanese is projecting 14% CAGR in EPS over the next five years. According to my calculations, this is somewhat conservative; the potential applications of TCX are nothing short of phenomenal and I believe this is a case of management choosing to err on the side of caution. Celanese shares, at ~$38 at the time of writing, are not quite as much a bargain as they were this summer at $33. Nonetheless, assuming management's growth estimates are correct and also assuming expansion to a P/E of 15 as macro concerns fade and the market recognizes the potential value of TCX, the stock could be worth $90 or more three to four years down the road, representing a very solid return.
As will be discussed below, the dividend is less than impressive. However, the dividend payment has doubled from 4 cents/quarter in 2009 to 8 cents currently, so perhaps in the future the stock will offer a respectable dividend. There's plenty of room to grow, as the payout ratio is a miniscule 5%. For now, however, I am content to let the company reinvest earnings in fully developing and building out TCX technology.
Downside Risks/Variant View
While I personally don't put much stock in technicals (pun somewhat intended), it is worth noting that Celanese's stock chart suggests that investors should be prepared for the possibility of significant downside. The stock has a propensity for steep and rapid declines, and the dividend yield is nominal at best, doing nothing to put any sort of floor under the share price. QE3 (or as I prefer to call it, QE∞) significantly lessens the probability of a sharp pullback in the broader market. Nonetheless, investors who feel differently might consider writing put options at a price that would make you feel comfortable buying.
Moving on to what I consider to be more important, though - the fundamentals - an investment in Celanese is subject to significant geography-specific risk. In the latest Form 10-K filed in February 2012, the company provided several nice tables summing up each segment's sales by geographic region.
Net Sales To External Customers by Destination - Consumer Specialties
Note that each segment is heavily dependent on sales from Europe-Africa and the Asia-Pacific regions. Exposure to these regions ranges from a mere 60% for the Industrial Specialties and Advanced Engineering Materials segments to a heart-pounding 79% for the Consumer Specialties segment. Unless you've been living under a rock, you're likely well aware that the economies of both Europe and China could use an adrenaline shot (or three, or ten). Given that, it's no wonder that the company's July 2012 10-Q cited "unfavorable economic conditions in Europe and Asia" twice and "unfavorable currency impacts" seven times. In some cases, a macro beatdown of stocks is somewhat unjustified - did Procter and Gamble (NYSE:PG) or Coca-Cola (NYSE:KO) really become any less valuable after the fall of Lehman? In this case, though, it's different; continued weakness in Europe and Asia could significantly impede sales as well as margins. Therefore, the uncertainty surrounding the stock is somewhat justified.
In spite of the potential downside risks listed above, and in spite of the fact that the deep value investor in me absolutely despised buying a company that had rallied 23% in two months (at the time of my initial purchase), I believe that Celanese is a solid buy at these levels. Under fairly conservative growth projections, the stock could double within 3-4 years, before TCX even starts to see widespread use. While it is certainly possible that the stock performance may be flat (or worse) in the near future, I believe that the market is not fully aware of the enormous potential inherent in the company's TCX technology. Converting local/inexpensive hydrocarbons into an easy-to-burn fuel is the Holy Grail of energy. Given the low valuation and high growth potential, I believe Celanese is a strong buy at the current price. I initiated a position at around $42, and have used dollar cost averaging to add shares in both taxable and tax-free accounts as the price has dropped. On availability of fresh capital, I will continue adding to this position as long as the shares remain below the $45 level.
All comments are welcome, whether you agree or disagree with my premises and conclusions. What are your thoughts on Celanese?
Disclosure: I am long CE. I wrote this article myself, and it expresses my own opinions; these views are mine personally and should not be taken to represent Seeking Alpha. I am not receiving compensation for this article. I have no business relationship with any company whose stock is mentioned in this article.