Celanese Corporation: Great Company At A 'HOLD'

Celanese Corporation: Great Company At A ‘HOLD’

Celanese (CE) has made an impressive journey, eclipsing by far even its pre-pandemic valuations. My own article on the company looks very good in context.

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(Source: Wolf’s Coronavirus Discounts – Celanese Corporation)

It goes to show you that annualized rates of return of three digits isn’t the exclusive domain of growth stock investment, but can be achieved when investing at quality companies at great undervaluation.

Today we take a look at the company at current valuations, as my system and price target views the stock as overvalued nearly 20%. We’ll look at how much return you can expect when investing in the company today.

Celanese Corporation – How has the company been doing?

In my original article, I described the company as follows.

Irving, Texas-based Celanese, or Hoechest Celanese, is a Fortune 500 company. Diving straight in, the company, which was founded over 100 years ago, is the world’s leading producer of CH3CO – the chemical Acetyl.

(Source: Wolf’s Coronavirus Discounts – Celanese Corporation)

When we look at how things have progressed going into the rest of 2020, and 3Q20 specifically as the last quarter we can look at, we find:

  • Outperformance in key regions, such as Asia, compared even to 3Q19 on a YoY basis. Government spending in China and consumer sentiment recovery led to a YoY performance in sales of 6% on a full year basis, and double digits sequentially in key segments.
  • The outperformance carried over to the US market as well in the form of steady monthly growth. Improved demands for automotive, electronics and appliances has caused growth in the company’s Engineered Materials. The company sees continued outperformance due to the impossibility of long-term travel, meaning many consumers are spending on home improvements, which helps the company’s businesses to the tune of 35% sequential growth in Engineered Materials and 18% in Acetyl Chain.
  • Recovery was similar in Europe, with significant sales and production in Germany. Net sales recovered 9 and 22% in Engineered Materials and Acetyl Chain on a sequential basis.
  • Overall and on a global basis, the segments came in at close 3Q19 YoY levels across most segments, with margins coming in just below last-year levels.

So result-wise, sales are nearly all back to pre-pandemic or above pre-pandemic sort of levels. However, equally important are the pandemic changes the company has made over the course of COVID-19. This includes things like virtual seminars, live video customer support in the company’s manufacturing trials, excess liquidity due to savings, and audits using head-mounted cameras rather than simply, exclusive physical audits. The pandemic has forced companies to adapt, and Celanese is certainly adapting. The negative expectations some analysts had for the company’s results going into the coming quarters have at this point more or less been proven wrong.

Celanese PVOH Business Goes To Japan

(Source: Celanese)

Adjusted EBIT numbers for the company, while below 2019 numbers, are still coming in nearly $100M, or nearly 30% above 2Q20 numbers, and the company delivered an EPS of $1.95 adjusted, with Free Cash Flow above the levels even of 3Q19 YoY.

The positives aren’t limited to straight company results either. The company managed to divest its 45% investment in Polyplastics JV for around $1.6B, with the expectation being for this capital to be redeployed in new investments, not used for debt.

Celanese plans UHMW-PE production line installation | Engine + Powertrain Technology International

(Source: Image Source)

The company also repurchased shares in 3Q20, announced a new expansion of the existing Texas facility to meet Lithium-Ion battery solution demands. By 2022, the company will be able to produce 50kt of Lithium-ion batteries annually, making the company a major player in the field.

In terms of fundamentals, the company has also paid off its term loans taken in 2020 taken due to COVID-19, around $300M.

The company outlook is actually positive at this point due to the recovery. Even in November, the order book was continuing to grow and there’s no sign that the company’s activity would see reduced levels of demands. The company expects continued 4Q20 recovery and demand growth, and the new EPS expectations for Celanese is around $7-7.10. Going into 2021, the company is confident that trends there will provide a full recovery to pre-COVID levels at some point during that year.

FRANKFURT A.M. – CELANESE - Logistik, Transport, Spedition Schmidt, Heilbronn

(Source: Schmidt, Heilbronn, Celanese Germany)

In closing, company performance has been what you might expect of a qualitative business experiencing a demand recovery which was never going to be anything fundamentally dangerous under these specific circumstances. It confirms the short-term thesis I presented on Celanese in my previous article, and it certainly sets things up for meeting the long-term outperformance in the company.

Let’s look at company valuations.

Celanese – What is the valuation?

A reminder here that Celanese typically tends to trade at discount historical valuations of around 11-12X earnings. This makes the current average weighted valuation of 17-18X P/E particularly interesting – or perhaps disconnected from historical standards.

There is, of course, some reason for this.

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

First off, Celanese does have a credit rating from S&P recently between BBB and BBB-. This makes it a class 2 company, but despite this, there are significant positives to the company which we went through in the initial article. Looking at the current valuation, we can see that analysts looking at the company forecast an impressive earnings growth trend starting in 2021 and continuing into 2022. In fact, based on the current earnings growth and an earnings multiple of around 15X, the company’s current valuation could still be said to be acceptable.

49836612 16068992797598727

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

There is a lot of EV positives in these expectations. None of these positives are impossible or even unlikely, but the problem when considering a company’s upside like this is that you’re betting on a break with fundamental valuation historicals. Such breaks are extremely rare. It would be far more likely for the company’s valuations to normalize back to a level of 11-13X, looking at the company’s history. If you invested here, your returns wouldn’t then be 11.26% per year, but around 0.26% per year, a total of 0.75% until 2022. Even a savings account could potentially generate more here.

Looking at historicals, the picture gets even somewhat worse.

49836612 16068994188187647

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

While this sort of overvaluation isn’t yet enough to make me consider profit harvesting, if the company were to continue expanding its multiples from here on out, it’s not unlikely that I would choose to do so. There’s simply no viable case for me where the company is worth an 18-20X multiple. They haven’t even, as of yet, reached pre-pandemic sales numbers.

I won’t give the company a target higher than $105/share, which means that it’s currently 19.43% overvalued. Celanese has some great fundamentals. You’re looking at less than 36% LTM payout ratio in terms of EPS, a 15-year dividend tradition, exemplary management according to Morningstar, and a narrow yet existing moat. It’s the type of chemical company you want, I argue. 31% 5-year average DGR is beyond excellent, even if it’s likely so, somewhat skewed in the long term. However, the dividend is the very definition of “safe” here.

Street targets have shifted violently in a very short time. Less than 6 months ago, the average target from 18 S&P Global analysts for Celanese was less than $97/share – it’s now around $126.06/share. This makes the company still undervalued even by that mean. A quick look shows us that the mean increase is both an increase in stock low range targets, as well as a significant increase in the higher target ranges.

At the same time, analysts haven’t shifted their “BUY” recommendations. We still have more or less the same number of “Outperform” recommendations on the stock – one more compared to 6 months ago. Even some “underperform” recommendations have been added since June/September of this year. My interpretation of this is a lack of clarity as to what heights the company might be going.

I know my own purchase price for the company was beyond excellent. The proof is in the pudding, as they say. But I see no realistic case for an above-15X P/E multiple for the company in its current iteration in any scenario. In fact, I see no reason to excessively raise my price target, as I already counted the recovery as part of my original thesis.

My price target range for Celanese is therefore a historical average mixed with the forecast average of 2020-2022, which comes to a $97.5 based on an 11X P/E, and a $107/share based on a 12X P/E. That is my current target for the company, and it makes it overvalued in any of these scenarios.

The yield of below 2%, when my own YoC is nearly 2.8% only confirms the overvaluation somewhat.

Thesis

This article is part of my ambition to write about undervalued dividend companies that I view as “safe” for investment. The purpose of these investments is never staggering amounts of capital appreciation or growth found in some of the more growth-oriented strategies – but a market-beating rate of return that combines an appealing 2-6% dividend yield with a high likelihood of short to mid-term capital appreciation as the undervalued company reverts to a mean.

It’s my personal view that any investor should initially safeguard their life by focusing on constructing a fundamentally safe stream of income. Once this is achieved, one can focus on higher rates of capital appreciation which typically are accompanied by higher amounts of risk. My failures thus far have been limited to scenarios where I diverge from this logic.

man on rope

(Source: Unsplash)

When writing about these companies, I try to pick the most qualitative and secure investments, where a lack of significant downside is more important than a massive upside. The so-called best-of-breed, the best of their kind, the safest around – however you want to label them. I achieve this by picking companies with high credit ratings, good dividend coverage ratios, good historical results, good forecasts, and an appealingly fundamental operating model and market.

While Celanese is such a company, the valuation the company currently demands for investment is a no-go for me. 20% overvaluation is far beyond the margin of error I’m willing to play with at a yield of no more than 1.9%. The risk of investing here at what could essentially be zero rates of return for several years going forward makes me extremely cautious – and it’s my belief that you should be as well.

At today’s valuation, Celanese cannot be considered a “BUY,” even under the more positive scenarios. I don’t see a break with the company’s historical valuation tradition as very likely, which means that at 20% overvaluation (at most) the company is most certainly a “HOLD” here.

Disclosure: I am/we are long CE. 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: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.

I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.

Credit: SeekingAlpha

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