Kicking it Up a Notch; Upgrade to Hold from Sell
• Risk-reward is now more symmetric in our view. After lagging in 2017, UNVR shares have corrected 11.8% year-to-date vs. +2.2% for the S&P500 index, making the stock the second worst performer among the 18 names in our coverage universe, behind Hold-rated Albemarle (ALB) at -12.2%. We attribute the recent move to a combination of investor concerns regarding CEO succession and de-risking during the recent market downdraft, against the backdrop of Univar’s above-average net debt level of $2.7bn or 4.6x our estimate of 2017 EBITDA. Meanwhile, it is not obvious to us that Univar’s fundamentals have deteriorated. Indeed, we anticipate progress on volumes, aided by better demand growth and new supplier authorizations, although freight costs remain a concern for the industry. The next catalyst for the stock is likely to be the company’s 4Q17 earnings report on 27 February.
• We anticipate a smooth CEO transition. On 1 February, Univar announced that President and COO David Jukes will succeed well-regarded CEO Steve Newlin, who will become Executive Chairman of Univar's board of directors. While Mr. Jukes will have big shoes to fill, we view the move as unsurprising and logical – unsurprising in that Mr. Newlin came from the board to accept CEO responsibilities in unplanned fashion, following the departure of his predecessor Erik Fyrwald to run Syngenta – and logical in so far as Mr. Jukes has had success in...
• Volume outlook appears brighter, although freight costs remain a risk. In an effort to improve profitability, Univar has been shrinking volumetrically for three years now: -7% in 2015, -4% in 2016 and -5% YTD in 2017. In this context, we have wondered whether the discipline required to turn away low-margin business has been restraining upside, at least temporarily while the company hires new salespeople aggressively to develop higher margin opportunities. Looking ahead...
• New supplier authorizations could help a bit. When CEO Newlin first took over in 2016, we viewed Univar as being in “damage control” mode as it relates to US supplier relationships. Nowadays, things are looking up. In recent weeks, Univar has announced a flurry of new supplier authorizations with...
• We upgrade from Sell to Hold and trim our price target by $1. Our target dips by $1 to $30 from $31, mainly to reflect the downdraft in the equity capital markets since we had last revised our model. Our updated target of $30 suggests that UNVR shares offer total return potential of 9% (UNVR shares do not currently pay a dividend). We base our valuation of UNVR on an average of 3 methodologies: DCF, relative P/E multiple, and a relative EV/EBITDA multiple. Our DCF analysis supports a fair value of $33 per share. We apply a 0% premium to the S&P500 market P/E multiple (2018 basis) to generate a relative P/E value of $25, and finally we apply a premium of 1.0x to the average EBITDA multiple for our coverage average, which gives us warranted value of $30 per share. We remind investors that, unlike Univar, we do not add back stock-based compensation expense ($10mn in 2016 and an estimated $20mn in 2017E) to calculate adjusted EBITDA used for valuation purposes. We are pleased to see however that Univar has begun to report an adjusted EPS figure that includes the effect of stock-based compensation.
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Westlake Chemical (WLK: Hold, $115)
Vinyls Propels Solid 4Q Earnings
• WLK posted 4Q earnings near consensus. Our first blush analysis suggests that WLK printed EPS of $1.67, consisting of GAAP EPS of $6.15, less a one-time tax benefit of $4.53, plus $0.05 of transaction and integration-related costs. Thus, EPS came in $0.02 light vs. Street consensus of $1.69, yet comfortably ahead of our $1.48E. On a segment basis, earnings in Vinyls exceeded our forecast by a wide margin, while Olefins posted modest upside. The Olefins segment continued to benefit from elevated margins following the significant Hurricane Harvey-related outages in 3Q17 and the strength in underlying crude markets. That said, we continue to have more confidence in the sustainability of the Vinyls performance, which surpassed our estimate by $0.17 in EPS terms. EBITDA of $526mn was essentially in line with consensus and above our $493mn. We await the call to hear more about how any lasting Harvey or any FIFO accounting metrics may have impacted the quarter. Based on partial balance sheet disclosures, we estimate that net debt declined by $366mn sequentially to finish the quarter at $2.30bn or 1.1x our 2018 estimate of EBITDA.
• Olefins finished 2017 on a steady course. In EPS terms, Olefins earnings exceeded our estimate by $0.04 as the segment EBIT margin held steady at 32.1% vs. 32.9% in 3Q17 and 31.8% in 4Q16. Recall that 3Q17 results for the Olefins segment included a $14mn FIFO benefit, adjusting for which would result in a more comparable margin base of 30.2%. Results are impressive in light of an outage that Westlake suffered at one of the company’s LLDPE resin units in mid-December. The unit was offline for the remainder of the quarter, and was said to have returned to operations earlier this month. The press release did not quantify any impact this outage may have had on results. Looking ahead, while PE prices moved lower in December and discounts were said to have been given in January, markets have tightened due to low inventories and producer outages. As we discussed in our most recent Commodity Chemical Calculus (here), we anticipate this will drive PE prices higher by $0.04/lb in February, and will likely be enough to keep prices flat in March, before prices likely recede in April.
• Vinyls posted another impressive quarter. At $225mn of EBIT, Westlake’s Vinyls business easily eclipsed the $192mn that we had penciled in. Vinyls segment sales of $1.49bn outpaced our $1.43bn estimate, while EBIT margins of 15.1% eclipsed our 13.5% estimate. Maintenance expense was anticipated to be $25mn on the quarter, though the press release did not quantify the actual maintenance impact. We view the results as affirmation of our constructive thesis on Vinyls, including our expectation of continued price traction in the chlor-alkali market and improving margin trends in PVC. To that end, we currently expect caustic soda prices to increase by $10 per dry short ton and PVC margins to expand by $0.02 per pound sequentially in 1Q18. We note that Westlake has proposed a caustic soda price increase of $40 per dry short ton (DST) and a chlorine price increase of $30 per ton, which compare to Olin Corporation’s proposed increases of $85/DST and $25 per ton, respectively.
• CAV capacity expansions are in the cards for 2019-2021. In separate news, we note that Westlake announced plans to de-bottleneck chlor-alkali capacity at Gendorf, Germany and expand downstream Vinyls production capacity at three locations: Geismar, LA in the US and Burghausen and Gendorf at legacy Vinnolit operations in Germany. The plans include the addition of 750mn pounds per annum of PVC resin, which represents about 11% of Westlake’s current PVC capacity and 0.8% of global PVC industry capacity.
• We rate WLK shares Hold. Our target of $115 is based on an average of two valuation frameworks; a relative EV/EBITDA multiple and a relative normalized P/E multiple, each of which is supplemented by an estimated value of $4 per share to reflect financial engineering optionality associated with Westlake’s MLP affiliate, WLKP. Our relative EV/EBITDA multiple methodology, which yields warranted value of $115, incorporates a multiple discount of -1.5x vs. the group. Our normalized P/E methodology, which yields warranted value of $107, utilizes a 15% discount to the group average multiple as applied to our normalized EPS estimate of $7.65.
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