06.24.18
Albemarle Corporation (ALB: Hold, $120 PT)
The Sum of Two Fears
• Albemarle delivered solid earnings, but you wouldn’t know it from the stock price. Instead, we attribute Wednesday’s stock reaction of -10.0% vs. -1.1% for the S&P500 index to two related issues: (1) Albemarle’s large inflection in capex ($800-900mn in 2018 vs. $318mn in 2017) to support lithium capacity increases could cause FCF to plummet to negative territory in 2018 (-0.8% in our model); and (2) perceived acceleration of capacity growth across the global lithium industry is fueling investor anxieties regarding potential for future oversupply and consequent risk to selling prices. The latter has been a principal concern of ours since relaunching coverage of ALB shares one year ago. So, is it time to step up? We judge it to be premature to do so. While the market has developed a much greater appreciation for what we’ll call lithium cycle risk, that risk remains theoretical, i.e. we haven’t seen it manifested in the form of appreciably lower rates of capacity utilization let alone meaningful pressure on selling prices. Until that plays out, we suspect that Albemarle’s trading multiple is unlikely to re-expand anytime soon, at least in a sustainable way. Stated differently, while upside potential is admittedly enticing here, downside risk continues to concern us, so the overall risk-reward balance remains more symmetric than we would prefer. Thus, we maintain our Hold rating and trim our target in recognition of substantially higher capex, higher cash taxes, and lower FCF over the medium term.
• Our top 10 takeaways: (1) 4Q17 EPS of $1.34A ex items surpassed consensus of $1.21 and our $1.25E; (2) on a segment basis, operating earnings exceeded our forecast across the board, partially offset by more punitive corporate expense; (3) Albemarle’s lithium supply is committed through 2021; wave one lithium projects are “on track”, which implies available supply of ~165KTPA in 2021; (4) ALB will spend $1bn on lithium expansion projects, including >$0.5bn in 2018; ALB has the flexibility to adjust plans if the trajectory of demand changes; (5) lithium earnings are still expected to rise at least 20% in 2018 with volume growth of 10KTs, pricing up high-single digits, and margins >40%; (6) the company’s goal is to be the most profitable lithium business in the world, not to...
• We adjust our EPS estimates in mixed fashion. Following better than expected 4Q17 results, we are increasing our 2018 EPS estimates by $0.15 to $5.25. Changes reflect a higher earnings base in lithium and other segments in 2017 and lower interest expense due to greater capitalization thereof (no change in cash interest). Upside is partially offset by a projected tax rate of 23.5%, 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. Looking ahead to 2019+, we adopt a more aggressive posture on volume growth given an enormous increase in capex to $825mn in 2018. For context, this represents ~4.5x depreciation expense. We were above consensus previously with a capex forecast of $500mn and Street expectations of $416mn, so Albemarle’s budget is effectively double what the Street had penciled in. In contrast...
• We rate ALB shares Hold and reduce our price target to $120. We decrease our price target from $133 to $120, which suggests potential upside of 21%, including a dividend yield of 1.3%. 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 9%, a terminal growth rate of 3%, and a weighted-average cost of capital of 7.8% yields a warranted equity value of $116, down from $127 previously due to a substantial increase in capex, higher cash taxes, and lower projected FCF. On a relative P/E basis, we assign a multiple premium of 40% (down from 50% previously) to the S&P500 index multiple of 2018 net earnings, which results in a warranted equity value of $124 per share. ALB shares trade for 11.8x our 2018 EBITDA estimate as compared to 11.3x for other specialty chemical names and 9.7x for the average company in our coverage universe. On a relative basis, ALB shares currently trade at a P/E multiple of 1.11x 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.
(Please see full report for details)
The Sum of Two Fears
• Albemarle delivered solid earnings, but you wouldn’t know it from the stock price. Instead, we attribute Wednesday’s stock reaction of -10.0% vs. -1.1% for the S&P500 index to two related issues: (1) Albemarle’s large inflection in capex ($800-900mn in 2018 vs. $318mn in 2017) to support lithium capacity increases could cause FCF to plummet to negative territory in 2018 (-0.8% in our model); and (2) perceived acceleration of capacity growth across the global lithium industry is fueling investor anxieties regarding potential for future oversupply and consequent risk to selling prices. The latter has been a principal concern of ours since relaunching coverage of ALB shares one year ago. So, is it time to step up? We judge it to be premature to do so. While the market has developed a much greater appreciation for what we’ll call lithium cycle risk, that risk remains theoretical, i.e. we haven’t seen it manifested in the form of appreciably lower rates of capacity utilization let alone meaningful pressure on selling prices. Until that plays out, we suspect that Albemarle’s trading multiple is unlikely to re-expand anytime soon, at least in a sustainable way. Stated differently, while upside potential is admittedly enticing here, downside risk continues to concern us, so the overall risk-reward balance remains more symmetric than we would prefer. Thus, we maintain our Hold rating and trim our target in recognition of substantially higher capex, higher cash taxes, and lower FCF over the medium term.
• Our top 10 takeaways: (1) 4Q17 EPS of $1.34A ex items surpassed consensus of $1.21 and our $1.25E; (2) on a segment basis, operating earnings exceeded our forecast across the board, partially offset by more punitive corporate expense; (3) Albemarle’s lithium supply is committed through 2021; wave one lithium projects are “on track”, which implies available supply of ~165KTPA in 2021; (4) ALB will spend $1bn on lithium expansion projects, including >$0.5bn in 2018; ALB has the flexibility to adjust plans if the trajectory of demand changes; (5) lithium earnings are still expected to rise at least 20% in 2018 with volume growth of 10KTs, pricing up high-single digits, and margins >40%; (6) the company’s goal is to be the most profitable lithium business in the world, not to...
• We adjust our EPS estimates in mixed fashion. Following better than expected 4Q17 results, we are increasing our 2018 EPS estimates by $0.15 to $5.25. Changes reflect a higher earnings base in lithium and other segments in 2017 and lower interest expense due to greater capitalization thereof (no change in cash interest). Upside is partially offset by a projected tax rate of 23.5%, 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. Looking ahead to 2019+, we adopt a more aggressive posture on volume growth given an enormous increase in capex to $825mn in 2018. For context, this represents ~4.5x depreciation expense. We were above consensus previously with a capex forecast of $500mn and Street expectations of $416mn, so Albemarle’s budget is effectively double what the Street had penciled in. In contrast...
• We rate ALB shares Hold and reduce our price target to $120. We decrease our price target from $133 to $120, which suggests potential upside of 21%, including a dividend yield of 1.3%. 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 9%, a terminal growth rate of 3%, and a weighted-average cost of capital of 7.8% yields a warranted equity value of $116, down from $127 previously due to a substantial increase in capex, higher cash taxes, and lower projected FCF. On a relative P/E basis, we assign a multiple premium of 40% (down from 50% previously) to the S&P500 index multiple of 2018 net earnings, which results in a warranted equity value of $124 per share. ALB shares trade for 11.8x our 2018 EBITDA estimate as compared to 11.3x for other specialty chemical names and 9.7x for the average company in our coverage universe. On a relative basis, ALB shares currently trade at a P/E multiple of 1.11x 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.
(Please see full report for details)
