Broad-Based Strength Drives Operating Upside in 4Q
• Earnings surpassed expectations across the portfolio. The company posted 4Q17 EPS of $1.34A ex items vs. consensus of $1.21 and our more ambitious $1.25E. Sales grew 23% y-y to $858mn, exceeding the Street’s $797mn and our $774mn. On a segment basis, operating earnings exceeded our forecast across the board, partially offset by more punitive corporate expense. In EPS terms, EBITDA came in $0.10 ahead of our number, and $0.12 above the Street. A lower than projected 4Q tax rate of 16.8% further boosted EPS by $0.04 relative to our forecast rate of 19.5%. Please see our earnings variance table below for a full reconciliation of results vs. forecast. Net debt dipped $44mn q-q to $700mn or 0.7x our estimate of 2018 EBITDA. However, pro forma for the sale of the polyolefin catalyst business to Grace, we anticipate this net debt number will decline to ~$370mn, or less than 0.4x our estimate of 2018 EBITDA.
• Initial 2018 earnings guidance reads positive ex taxes and capex. Albemarle put forth a 2018 EPS range of $5.00 to $5.40, the midpoint of which is 1.4% above consensus of $5.13 and nearly 2% higher than our $5.10E. Bottom line guidance is perhaps a bit more constructive than meets the eye as Albemarle’s slide deck indicates a 2018 tax rate range of 23-24%, which is higher than the 21.4% that we had forecast due to directional pressure from both the US Tax Cuts and Jobs Act as well as higher mining and statutory taxes in Chile. In addition, Albemarle’s EPS guide now excludes the pending divestiture of Performance Catalysts Solutions (PCS), whereas we believe that not all of the Street has done so (we have). Adjusted EBITDA of $955mn to $1.005bn brackets our $975mn and consensus of $977mn with a midpoint that is a small fraction above the Street, but here again consensus likely includes a greater contribution from PCS. Sales are expected to grow 4-11% to a range of $3.2 to $3.4bn. Finally, in order to fund “accelerated investment necessary to supply long-term customer commitments”, Albemarle’s updated budget contemplates capex of $800-900mn, which compares to our estimate of $500mn and 2017 capex of $317mn.
• Lithium delivered again although margin contraction continues. EBITDA for Lithium and Advanced Materials came in at $136mn against our estimate of $132mn. Segment results were driven by better performance in Lithium while PCS results lagged modestly. Lithium sales grew 39% on volumes of 11% and price of 27%. The 27% price gain on the quarter represents slight deceleration from the rate of +32% y-y realized in 3Q17. While sales trends remain impressive, margin upside in lithium is being limited by royalty payments in Chile and non-capitalized exploration expenses. Incremental contribution margin of 36% (y-y) in 4Q came in lower than our estimate of 43%, resulting in EBITDA margin of 41.0%, or 190bps lower than the 42.9% that we had modeled. PCS was a modest $1mn headwind vs. our results as margins of 23.5% increased 430bps y-y, though still shy of our 25.7%. Looking ahead..
• Bromine benefits from better price. EBITDA trended flat sequentially, though increased 37.2% y-y, driving a beat vs. our forecast. In EPS terms, EBITDA of $64mn came in $0.04 ahead of the $59mn we had penciled in. We attribute the variance to better margins, primarily due to better than expected price gains. We had been cautiously optimistic on Bromine performance entering the quarter given strength in domestic Chinese elemental bromine prices. However, looking forward...
• Refining Solutions finishes the year on a high note. EBITDA of $69mn represents impressive 21% y-y growth for Refining Catalyst profitability, and is a $0.03 per share tailwind in EPS terms, vs. our $65mn. Refining results struggled in 3Q due to Hurricane Harvey related outages, though larger HPC orders were expected to help buoy 4Q results. While Hurricane Harvey remained a headwind to the quarter at $5.5mn, results reflect the improved backdrop in both HPC and FCC sales. Looking forward...
• We rate ALB shares Hold with a price target of $133. Our target of $133, suggests potential upside of 20%, including a dividend yield of 1.2%. Our target is based on the average of two methodologies: DCF and relative P/E multiple. Our 10-year DCF analysis featuring a stage one EBIT growth of 7%, a terminal growth rate of 3%, and a weighted-average cost of capital of 7.8% yields a warranted equity value of $127. On a relative P/E basis, we assign a multiple premium of 50% to the S&P500 index multiple of 2018 net earnings, which results in a warranted equity value of $138 per share. ALB shares trade for 13.2x our 2018 EBITDA estimate as compared to 11.3x for other specialty chemical names and 10.0x for the average company in our coverage universe. On a relative basis, ALB shares currently trade at a P/E multiple of 1.31x that of the S&P500 index vs. a 5-year average of 1.05x. We view this relative premium as elevated yet defensible in light of robust lithium demand growth, portfolio upgrades in recent years, and an under-leveraged balance sheet.
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W.R. Grace and Co. (GRA: Buy, $82 PT)
Investor Day Preview; Growth in Focus
• We expect Grace’s growth potential to be a key topic of interest. WR Grace will host an investor day at the New York Stock Exchange on the morning of Friday March 2. Ahead of the event, we anticipate investor focus on three growth-related topics: (1) the likely trajectory of Grace’s overall earnings growth beyond 2018; (2) growth prospects in polyolefin catalysis, supported by the nexus between catalysis and technology licensing; and (3) long-term growth in demand for FCC catalysts. We explore each of these issues in the sections that follow and conclude that Grace’s strong competitive position should facilitate EPS growth at a premium of 100-200bps relative to the chemicals sector average over the medium- to long-term. In this context, we consider risk-reward prospects to be attractive, following a period of under-performance of GRA shares. We reiterate our Buy with a price target of $82, which suggests upside potential of 23%.
• Earnings trajectory: look for operating income to accelerate in 2019. By way of background, Grace’s 2018 EPS growth forecast of 9-12%, or +3-5% excluding the effects of pending M&A and the new US tax regime, disappointed investors and sent shares reeling –8.0% vs. –3.8% for the S&P500 index on 8 February. We continue to view Grace’s 2018 EPS range as conservative, but that aside we see at least two dynamics that should support a better underlying growth profile in 2019+. First...
• ALB is building a fortress position in polyolefin catalysis. Potential for catalyst industry consolidation has been part of our constructive thesis on Grace, which has been building upon its leadership position through organic investment, supplemented by three important deals in recent years: (1) the acquisition of Dow Chemical’s Unipol polypropylene catalyst and licensing business in December 2013 for $500mn; (2) the acquisition of BASF’s polyolefin catalysts in July 2016 for $250mn; and (3) the pending...
• Polypropylene (PP) resin technology licensing complements related catalyst sales. As shown in Figure 4, the frequency and magnitude of Grace’s licensing deals has picked up quite a bit, with five deals announced over the past six months. We generally like technology licensing businesses because they tend to feature oligopolistic market structures, defensible technology moats, and sustainably high margins supported by low marginal costs. However...
• How will demand for FCC hold up as electric vehicles proliferate? We expect electric vehicles (EV) to account for 12% of global auto production in 2025 vs. ~2% in 2017. Given rapid growth in the EV market, many investors are concerned that demand for gasoline -- and therefore demand for FCC catalysts used to make gasoline – is likely to erode. While we do not dismiss the potential for robust growth in demand for EVs, we do view the impact on FCC demand as quite manageable for two reasons. First…
• We look forward to a brief update on growth opportunities in Materials Technology. Grace’s Materials Technology segment products (silica et al.) are primarily sold into the coatings, consumer/pharma, and chemical processing markets, each targeted for their stability and the opportunity to deliver value add products. The opportunities for Grace to expand this business are robust as the company’s …
• We maintain our Buy rating and target of $82. Our price target of $82 suggests total upside potential of 23%, including a dividend yield of 1.4%. GRA shares now trade at a 2018 P/E multiple of 17.5x, unadjusted for an estimated $4 per share in net present value (NPV) of tax assets, and 16.5x our 2018 EPS as adjusted for the NPV of tax assets. This tax-adjusted multiple represents a discount of 4.0 turns or 20% vs. the average specialty chemical company, and a slight premium to the median 2018 P/E multiple of 16.2x for our entire coverage universe of chemical stocks. Our valuation of GRA is based on an average of two methodologies: DCF analysis and a relative P/E framework. Our DCF analysis suggests a warranted stock price of $82, which incorporates an advantage cash tax rate of 14% through 2025 as well as a WACC of 7.9% and a terminal growth rate of 3.0%.Using our relative P/E framework wherein we apply a 20% premium to the S&P500 multiple, we calculate warranted value of $82 per GRA share.
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Univar Inc. (UNVR, Hold, $30 PT)
4Q EBITDA Beats Street by a Bit; 2018 Guide Looks Good
• Univar posted solid 4Q results. Univar reported adjusted 4Q17 EPS of $0.34 vs. consensus of $0.22 and our $0.21E. Below the line items, principally other expense, accounted for the EPS variance vs. our forecast, while adjusted EBITDA of $148.5mn was essentially in line with our $148mn and above consensus of $144mn. Sales of $1.96bn came in shy of our $2.00bn but appreciably above consensus of $1.87bn, while adjusted EBITDA margin expanded 20bps to 7.6% vs. the 7.4% that we had penciled in. On an EPS basis, earnings were within $0.01 of our forecast for all of Univar’s five segments. Net debt declined by $249mn to $2.43bn or 3.8x our 2018 estimate of EBITDA.
• 2018 earnings guidance looks good apples-apples. Full year 2018 EBITDA guidance of low-double-digit growth is perhaps a bit ahead of our 10% estimate and implies a range of $653-665mn (at +10-12%) as adjusted for Univar’s new pension accounting methodology, or $665-675mn on a basis that is more comparable to existing Street estimates. On an apples-apples basis, the EBITDA guide points to modest upside vs. our estimate of $664mnand more appreciable upside vs. consensus of $657mn. This new EBITDA range drives a 2018 EPS guide of $1.60-1.80 per share, which is ahead of the Street at $1.56 and likewise ahead of our forecast of $1.45E. Univar’s new 2018 tax rate range of 20-25% is generally in line with our forecast rate of 23.2%. Management expects tailwinds from mid-single-digit revenue growth on improved sales force execution as well as ongoing cost productivity gains to be the primary drivers of performance. For 1Q18, the company expects adjusted EBITDA growth of 10%, which is in line with our forecast.
• USA came in a touch light vs. our model on lower sales. In EPS terms, segment EBITDA of $87mn was a slight miss of $0.01 in EPS terms vs. our $89mn, driven by a weaker than expected top line. Gross margin in the segment trended relatively flat sequentially, but did finish up 30 bps y-y and helped drive a 10bp beat vs. our model. The press release did not flag any hurricane-related headwinds on the quarter, although we had been expecting a $6mn headwind given the company’s prior guidance. Sales of $1.13bn increased by 4.3% y-y as Univar reported its first quarter of sales growth in three years. Looking forward, we expect revenues to accelerate on the back of sales force initiatives and an improved macro backdrop.
• Canada finished in line. EBITDA of $28mn was exactly in line with our estimate. Sales grew 12%, a bit less than we had anticipated, as we perhaps overestimated the impact of the oil price rally and CAD strength. EBITDA margin of 10.3% is a new high water mark for the segment, and an impressive sequential acceleration from the 8.5% reported in 3Q, despite more marginal expansion on a y-y basis.
• EMEA beat our estimate by $0.01 in EPS terms. EBITDA of $33mn exceeded the $31mn we had penciled in. Sales grew 17% y-y, well ahead of our 9% estimate as the company benefited from sales force execution, a stronger Euro and better prices. That said, it appears mix was a headwind and drove a marginal EBITDA miss vs. our model. Looking forward, we expect that FX will continue to be a tailwind through 1H18.
• We rate UNVR Hold with a $30 price target. Our target of $30 suggests that UNVR shares offer total return potential of 8% (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.
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