Description

Celanese is a well-managed, nichy high-margin chemical company with a pending transformational acquisition in one business line and an unmatchable global low-cost position in the other major business line. The business, in general, has decent growth prospects, is currently cheaply priced at 6-7 current year earnings and we think it has a very reasonable path to get to a roughly 25% FCF yield in the next five years, therefore offering great upside. If history is any guide there should be plenty of opportunities to sell the business at a much lower FCF yield than that (see below). The business is nicely cash generative and capital allocation has been very good over the years, including the recently announced acquisition (we think).

The two major business lines of the company are somewhat cyclical but are generally able to stay profitable during recessions (including the global financial crisis and China commodity market flood time frame) and don’t face exactly the same dynamics. The industry backdrop over the next few years should be quite favourable (more on that later) unless we get a long deep global recession. Including the acquisition, both business lines contribute around half of the earnings. Going into more detail about the whole company at this point doesn’t really make much sense, so I will tackle the businesses separately. Let’s start with the Acetyl business. 

Acetyl business

Celanese acetyl business is active in the production of acetic acid and various acetyl-based intermediaries like VAM (vinyl acetate monomer) and VAE/EVA (vinyl-acetate + ethylene) plus all the way down to end products like RDP (redispersible powders). Acetyl products end up being used in a broad variety of industries and end-markets, the largest of which are paints & coatings, adhesives and paper and packaging but it ends up in many more places. Sales are global with roughly a third in America, a third in Europe and a third in Asia.

Acetic acid (CH3COOH) has methanol (CH3OH) and carbon monoxide (CO) as its major raw materials inputs, both of which basically have to be available in close proximity to your production facility. Next up is ethylene for the production of VAM or VAE/EVA further down the chain. Celanese uses between 40-60% (depending on market conditions) of its acetic acid internally to produce downstream acetyl products. The chain goes as follows (without really going into more detail): 

• Acetic Acid (CH3COOH) = Methanol (CH3OH) + Carbon monoxide (CO) 

• Vinyl Acetate monomer (C4H6O2) = Acetic Acid (CH3COOH) + Ethylene (C2H4) 

• VAE (vinyl acetate ethylene) emulsion = VAM + Ethylene (<50%)  

• EVA (ethylene vinyl acetate) resin or powders = VAM + Ethylene (>50%) 

• RDP (redispersible powders) = production from VAE emulsions 

Acetic acid and acetyl products are commodities with prices influenced by regional and global supply and demand situations. Prices are of course also heavily dependent on the prices of the main raw material inputs. The global demand for acetic acid is around 15m tons. One step further down the chain, the global capacity of VAM is around 4m tons. The use of acetyl products is deeply ingrained into long-established production methods of the respective goods and products where it is used and there really exists no relevant replacement risk. Normalized demand growth in the industry basically matches global GDP growth. If you want to do well in this business you need a cost advantage.

Celanese is the largest acetic acid producer in the world with a current capacity of 3,3m tons (~20% global capacity) going to 4,6m (going to ~27% of global capacity) next year. In VAM Celanese has a capacity of 1,6m going to 1,75m over the next years, so the company has an even higher global capacity share in VAM based on ~4m tons of demand. 

In terms of costs, Celanese is the low-cost leader with a sizable advantage. The cost advantage stems from a combination of process technology that offers the best conversion rates in the industry, its large-scale plants - where the most important one in Texas is about to double its capacity next year - and a feedstock cost advantage, given that close to half (and more in the future) of its production capacity is based in Texas with access to globally cheap natural gas. The facility is also backwards integrated into methanol (which covers 40% of internal demand) and also into carbon monoxide production.

On top of the cost advantage, the business has a margin optimization opportunity stemming from a global production footprint and operations across the whole chain that allows them to shift volumes around to maximize earnings. No other competitor comes close to that optimization ability along the chain. Usually, competitors are operating in one to two parts of the chain, the same goes for geography and they also have smaller facilities with a larger fixed cost component that would make Celanese’s volume scaling approach much more difficult to implement. Here is a list of names of noteworthy competitors and how they are positioned. Celanese has no good peer to look at for comparisons since it is nobody else's main business and it is, therefore, lumped together with something else. 

About a decade ago Celanese changed its incentive system and the goal of the business became to focus on the overall profitability of the acetyl business rather than the individual components of it. They have improved on that approach since and nowadays basically decide on a daily basis depending on the various market conditions along the chain, where to lower vs. to increase volume, where to move it to regionally - locally vs. different regions - and how much to use internally vs. externally to maximize the profits of the overall acetyl business. 

The acetyl business has become more diverse and of higher quality over time, with the extension of the chain and capacity additions over the last few years. Celanese currently only sells around 40% of acetic acid the rest is used internally. Earnings come 50% from acetic acid, 25% from emulsions and powders and 25% from VAM + anhydride/esters. All of which have kind of their own supply and demand pictures, but they are of course still quite correlated over time. Here is a quick EBIT and margin history with some business milestones starting with the financial crisis and ending with the pandemic. Last year everything became very capacity constrained and annualized EBIT since then is $2b - more on that later.  

Taking the cost advantage and the downstream margin opportunities together, Celanese has a substantial EBIT margin advantage over its competitors, which we believe is on the order of 15%. This business will still generate profits when the industry as a whole is suffering losses. Now, a little bit more info on the industry perspective, starting with a demand and utilisation illustration over the last decade, ending with the pandemic. 

We think the business prospects have much improved over the last decade and industry utilisations will remain tight over the next several years given the current lack of announced new projects and the multiyear timeframes required for new capacity to get built. The world really hasn’t seen any meaningful acetic acid capacity additions since China’s massive top-down coal-based industrial complex overbuild phase after the financial crisis which also included a built out of acetic acid (it can be produced from syngas coming from coal). All capacity in China is coal-based, mostly small-scale, high cost and comparatively dirty and air polluting. Given the policy shift over the years, the Chinese have very likely lost the appetite to meaningfully expand capacity again and there is nothing meaningful in the works atm. We think the times of 15% EBIT margins over several years for this business won’t be repeated anytime soon. 

Outside of China the world hasn’t seen any meaningful capacity additions since at least the financial crisis and Celanese’s new Clearlake expansion (announced in 2019) that comes online next year, basically tells everyone else to not even think about projects, given their new facility can absorb many years of demand growth and nobody else can come close to their operating cost structure (as well as built cost for that particular capacity). The new facility is an expansion project and will share many costs with the already existing Clearlake facility, lowering their combined costs at full utilisation. Another important aspect is, that they can grow into the demand over the years and don’t have to ramp the facility meaningfully from the getgo, given its expansion setup vs. a greenfield built. The facility will immediately add $100m EBIT due to productivity gains with the potential of a lot more over time. There are other projects currently in the works that will add to the earnings power of the business over the next years. Celanese is not only the lowest cost producer of acetic acid they can also claim the title of having the “greenest” acetic acid in the world, which is not meaningless in the current worldview. 

Over the last five quarters, the business produced an annualized EBIT of around $2b given tightness in the markets across the whole chain. More normalized earnings are probably closer to $1,5b but the expansions and growing underlying global demand over the years will lift that figure further so $2b in a couple of years can be the new normal. Even though earnings are sort of peakish atm we like the business prospects given their well-protected leading cost position along with the growth opportunity coming from the Clearlake expansion and the lack of anyone else adding capacity.  

Engineered Materials business

This business takes in raw materials, mostly oil-related commodity inputs to produce a broad set of high-performance speciality polymers that are used in a wide range of end markets. For around 50% of those polymers (by sales volume), Celanese is backward integrated into the actual polymerisation (creating the resin itself) of those polymers. For the other half Celanese “only” does the compounding of the polymers which means functionalizing/mixing the polymer resins together along with other substances to achieve and/or enhance certain desired properties. Celanese was already a leader in this business but with the acquisition of Dupont’s specialty polymer business, Celanese becomes the gorilla in terms of breadth and depth in the specialty polymer world. No other company will come close, more on that later.   

The specified polymers are sold to OEMs or their suppliers all across the world in a mostly compounded pellet form, that they in turn then mould (via various moulding technics) into the desired shapes and forms of their intended parts. The end-markets are broad-based but the auto sector is half of the business. Celanese is usually already involved in the development phase of the products where they sit at the table of the OEM as a solution provider for their new product ideas or product improvements. Celanese helps with regulatory and certification aspects of the material and they usually also help the customer to achieve either light-weighting or sustainability goals alongside other material property improvements or targeted cost-cutting initiatives for new product designs. The OEM doesn’t care if Celanese actually does the polymerisation itself or not, but Celanese of course does care due to the economics and also the access to the material. 

Trademarks and patents are not the most important thing in this business but they also do matter. For some polymers, the trademarks are synonym for the specific polymer family. Dupont owned rather strong brands and with the combination, Celanese will have a fantastic position going forward. The acquisition is also very complementary, with respective high market shares in different polymer families. Where there was a large overlap, for example in POM. Celanese left out that piece because the combined company would likely end up with close to 60% of global capacity and therefore high chances of not getting a regulatory nod for the acquisition.  

We think Celanese has around a 30% market share across its important polymer families and with the combination with M&M, some auto OEM customers will get over 50% of their speciality polymer needs from Celanese. Going forward, basically, everyone will work with Celanese and there will also be new cross-selling opportunities. For example, Celanese had no relationship with Toyota but M&M did, and once you sit at the table you can offer the whole breadth of the combined portfolio for their new product developments. 

Celanese goes after large projects and rather uniquely also quite small projects too. The company continuously sees many new product developments and basically decided on a daily basis on which ones to bid on to optimize the overall margins of the business in the future. The time from participating in the design of a new product to finally booking revenue for that specific polymer can take quite a while - everything from a couple of months for a simple industrial application up to five years for more complex overall developments is in the cards. The average revenue per project (which is defined as one specific polymer for one application of one customer) is only $100k for Celanese. The smaller dollar projects usually carry higher margins and face less competition and Celanese has an operational model catered to work on many small projects.

Overall, the competition in this business seems rather limited to us and we think the situation will improve with the acquisition of Dupont’s M&M business. There is usually only a limited number of companies competing for the same projects, given the development nature of it and the consolidated market structure in many speciality polymer categories. For the projects Celanese bids on, the win rate is close to 50%. Generally, one company wins the project and depending on the importance, there may only be a second source supplier with the specified material in place for the client to supply them during the production phase. This all leads to a business with quite high EBIT margins at ~25% and high returns on capital with low maintenance capital requirements. 

Below is the performance history of the business over the last decade. The EBIT below does not include the JV income that they get from two JVs and of course, it ends in 2020. Since then the company acquired Santoprene (another good long-established brand and polymer addition for them) from Exxon last year (link) and most importantly there is the pending M&M acquisition that will basically double the size of the business going forward. 

Celanese has outgrown its underlying markets over the recent years and has gained market share. Based on already won projects it sees double-digit growth rates ahead. Generally, it is still mostly a GDP type of underlying growth business but there are more speciality polymers going into autos (which is 50% of sales), especially EVs going forward. Also, electronics, the energy sector with increasing solar and battery needs are demand areas outgrowing global GDP. Below is an illustration of what Celanese believes that the overall amount of polymer content per vehicle for ICE, hybrid and EVs are (for legacy Celanese). They also seem to be very well positioned with their GUR polymer (UHMW-PE) that goes into Lithium batteries. You will lose some other polymer content but overall going from ICE to EV is a gain for them.   

Another aspect we like about the auto exposure is that the current global auto built rates are also already in a kind of a supply-side induced recession and in combination with the record low inventory levels we think there is decent upside over the next several years from the current unit level. Of course, it could get a bit worse from here if things get really nasty, but we think it wouldn't last long if it happens. 

Coming back to the acquisition. Celanese has agreed to pay $11b all cash for the business that they think does $900m in EBITDA this year. On top of that, they see $450m in synergies for the combined especially polymer business. Borrowing another slide below shows how they think the synergies break down. Historically the company has been conservative with its estimates and has done well with its past acquisitions on the speciality polymer side. Celanese runs a very lean and dedicated business with well-incentivised employees down to the factory levels. Dupont hasn’t run the business with the same focus and dedication, which also isn’t too surprising. Celanese thinks Dupont has left money on the table, especially in their manufacturing facilities, but they have also generally run the business a lot less lean. For example, the M&M business alone has a larger finance department than the whole of Celanese has, which is telling. Celanese also sees opportunities in cross-selling and in applying their project model (extend bidding and work to smaller projects, more planning to optimize the overall margin). The salesforce can also be optimized, a person at a customer can now sell the whole portfolio, and therefore you need fewer people. You can also streamline and optimize the compounding facilities of the combined company. It all seems plausible to me and I tend to believe them given their performance on past acquisitions.

Combing back to the combined business

The business quality and prospects are were good and we think currently underappreciated. However, a concern is the new leverage that they are taking on with this acquisition. They plan to keep their investment-grade rating, but I am not sure that is possible. Regardless of that, the leverage that they are taking on is certainly manageable in my mind regardless of their rating status. Given the FCF generation of the business and its recession-resistant profitability. They have committed to getting below 3x leverage by the end of 2024 but internally think they will get there a year earlier, which is achievable, without a global disaster (a normal recession should be ok). Current proforma EBITDA is over $4b. FCF even with a massive working capital hit from inflation should be around $2b for the combined business this year. They see capex over the next few years maintained at around $0,5b due to less growth capex in both businesses (acetyl and EM). Historically capex ran mostly at 5-6% of revenue, with maintenance capex at less than that, the company claims half that amount for mcx. 

Historically they have run a conservative balance sheet and they want to get back there (see chart below, which is a bit outdated but still representative). So capital allocation over the next few years is pretty clear. Bridge financing is in place but they still need to issue the long-term bonds for the acquisition. So they are exposed to interest rate risk and further spread increases. New issuances will again be a mix including EUR so there is some relief, but it is still a concern. The issuance might come earlier than closing sometime in late summer, but who knows. It’s a risk. The bond markets, for now, seem to be quite comfortable though. All of their outstanding bonds are still trading below 5% and the credit spread on their longest dated US debt (2026) for example is only 150 bps.

Celanese has a third business called Acetate Tow that runs at 40% margins, is highly cash generative and produces ~$200m in EBIT. However, it is mostly cigarette filters and a slowly declining business. I am sure if they find a suitable buyer for a transaction that doesn’t destroy shareholder value they are very willing to sell it, given their deleveraging ambitions. They are probably very actively looking already. 

I wanna leave you with two more not very well formatted charts and the meaningless fact that will still bais you that Berkshire recently bought a 7,5% stake in the business. The business is currently becoming cheaper by the day along with commodity names due to recession fears. I am not great at timing but I think it has become cheap and is safe enough to generate great returns over a multiyear timeframe from here. Will it become cheaper in the meantime, maybe, who knows? The biggest risk is underestimating the cyclicality of the business, but its earnings history and structural improvement over the years leave us optimistic enough even with rough times ahead. Another risk is US natural gas getting expensive vs. oil and coal, which doesn't seem likely to us.

Catalyst

Ongoing strong earnings performance

M&A closing

Berkshire buying more