Separating Signal from Noise
• Air Products posted a bit of a choppy quarter. F1Q results were characterized by several transitory issues. To name a few, these include a plant sale in China, a price boost from spot sales of gases in Asia, expiration of a US merchant gas supply contract, and elevated maintenance costs that compressed margins in the US. Oh, and did we mention that tax rates stepped down? In attempting to look through all of this “noise” our analysis suggests that APD is moving in the right direction fundamentally, albeit with a more shallow trajectory of baseline volume growth (i.e. ex project contributions) at +2% vs. +5% at PX. That having been said, we consider consensus EPS and Air Products’ new F2018 EPS range to be conservative for three reasons: (A) the Lu’An deal remains excluded from guidance and (probably) certain analyst estimates (it is in our numbers); (B) a new tax rate range of 20-21%, which is significantly better than we had surmised from our recent tax work; and (C) the vastly under-leveraged nature of Air Products’ balance sheet with net debt of 0.1x EBITDA. Following the 2.4% pullback on Friday’s session (vs. +1.2% for the S&P500 and +1.4% for PX), APD shares now trade for a discount of fully 2.0 turns relative to PX (standalone basis) on our CY18 EBITDA. We suspect this gap won’t widen much further.
• Our top 10 takeaways: (1) adjusted F1Q18 EPS of $1.79A exceeded our $1.70E, consensus of $1.66, and management’s guided range of $1.60-1.70; (2) sales increased 18% to $2.22bn, well above our forecast of $2.09bn with the principal variance attributable to a contract termination and plant sale to a steel customer in Asia; (3) ex the sale in Asia, volume grew 7% from new project contributions of 5% and baseline growth of 2%; (4) adjusted EBIT of $461mn came in light vs. our $480mn and consensus of $477mn, principally due to weaker than expected earnings in North America, partially offset by upside in Asia; (5) in EPS terms this resulted in a negative variance of -$0.07 vs. our model, which was more than offset by stronger equity income +$0.03 and a boost of +$0.13 from a lower 1Q tax rate of 17.5% vs. the 23.5% rate that we had modeled; (6) project backlog trended....
• Changes to our model: We raise our F2018 EPS estimate by $0.10 to $7.50 from $7.40, mainly to reflect the benefit of an even lower tax rate (20-21%) than we had projected. Our model now reflects stronger projected sales growth in F2018, fueled by somewhat larger price contributions and more favorable FX, and further supplemented by the sale of a plant in China in F1Q18. However, associated EPS contributions are mitigated by a less favorable outlook for margins. We now forecast an F2018 EBITDA margin of 32.5%, down 100 bps from our prior model to reflect under-performance in F1Q (higher maintenance costs) and potential for ongoing challenges related to the expiration of a US merchant gas supply contract and perhaps cold weather-related outages as well. Finally, we note that our F2018 estimate of $7.50 includes ~$0.10 of benefit from the company’s pending deal with Lu’An, whereas the company’s guidance range of $7.15 to $7.35 does not incorporate the Lu’An deal.
• We rate shares of APD Hold and maintain our price target. Our price target of $164 suggests rather limited potential for upside, including a dividend yield of 2.6%. We value APD based on an average of our DCF analysis and a relative P/E-based framework. Our DCF analysis suggests a warranted stock price of $159 and includes a weighted-average cost of capital (WACC) estimate of 7.8% and a terminal growth rate of 2.5%. In our relative P/E multiple methodology, we apply a 25% premium to the S&P 500 multiple, supported by an unlevered balance sheet. This implies a stock price of $170.
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Celanese Corporation (CE: Hold, $116 PT)
Ratcheting Numbers Higher; Tax Break Better Than We Had Expected
• Acetyls propelled CE to a strong finish in 2017. While EPS was ahead of the street on the quarter, results were in line with our estimate, and less appealing in terms of mix. Margins in AEM continue to compress -- likely for reasons beyond deal-related dilution -- driving consecutive EBIT misses in the higher multiple portion of the company’s portfolio. Meanwhile, we are pleased to see Acetyls performing well, though we are hesitant to extrapolate the recent parabolic price surge too far into the future. Thus, our level of excitement about the commodity outperformance on the quarter is tempered. Without the lower than expected tax rate, 4Q EPS would have come in a nickel shy of our estimate. Taking a step back, we continue to have faith in CEO Rohr as a savvy steward of shareholders’ capital and we remain intrigued by potential for strategic optionality in Acetyls. However, at this point, we do not see overwhelming value in CE shares on a sum-of-the-parts basis, and, as a practical matter, we’d like to see the European Commission approve the pending acetate tow JV with Blackstone by mid-2018 in order to assign any further “option value” on portfolio actions. Thus, we remain Hold-rated, with a moderate increase in our price target of $7 to $116 from $109 to reflect positive, tax-inspired revisions to our estimates and recent multiple expansion across the industry.
• Top 10 takeaways: (1) adjusted EPS of $1.98 was in line with our $1.98E and ahead of consensus of $1.87; (2) core EBIT was a $0.05 per share miss vs our estimates; (3) a lower than expected tax rate of nearly 16% was 2% below the 18% we had penciled in; (4) segment mix was less favorable as commodity acetyls outperformed, while AEM lagged our forecast as margins eroded more than expected; (5) organic volume in AEM grew 13% in 4Q17 and 2017; (6) management is forecasting increased volatility in the acetic chain in 2H18, with guidance implying a retracement in profitability; (7) while the company did not formally commit, the probability of CE building out a second US methanol plant appears to have increased; (8) CE seems to be assessing strategic options for...
• We raise our 2018 EPS estimate by $0.15 or 1.8%. We increase our 2018 EPS estimate to $8.50 from $8.35, primarily as a result of a lower projected corporate tax rate following passage of the US Tax Cut and Jobs Act. Carry through of this new lower tax rate is also driving our 2019 EPS estimate higher, now at $9.15 up from $9.00. We did take our segment EBITDA forecasts up slightly on the back of a stronger profitability in Acetyls and a more favorable FX environment. However, offsetting this strength are lower expectations from Consumer and Industrial segments as well as higher corporate, depreciation, and interest expense.
• We rate CE shares Hold but increasing our price target by $7 to $116. Our target suggests shares offer moderate upside of 6%, including a dividend yield of 1.7%. As a reminder, we value Celanese based on an average of three methodologies; DCF analysis, a relative P/E framework, and a relative EV/EBITDA framework. Our DCF suggests a warranted stock price of $150. Using our relative valuation framework, our P/E multiple implies a fair value of $105 while our EV/EBITDA implies a fair value of $93 per CE share.
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