Description

Investment Thesis

Constellium, a global producer of engineered aluminum products sold into the automotive, aerospace and can sheet end markets, is a compelling equity investment with 44% upside over the next 6-18 months, based on the $19 average price derived by applying an 8x multiple to our 2018 and 2019 EBITDA estimates. The company is in the midst of a successful turnaround, with demand accelerating, leverage falling, and new management gaining credibility. The business is stable due to long term contracts, insulated from commodity risk, and a beneficiary of the shift to electric vehicles, which typically require highly engineered aluminum auto bodies and parts. Constellium is one of only four producers in the United States with the know-how and certification to produce aluminum sheet for auto bodies for the automotive industry. Additionally, Constellium has some of the only spare capacity among its competitors and is in active negotiations for a long term contract to expand its capacity. The company trades at a 2.5x turn discount to its comps based on 2018 and 2019 EBITDA estimates, in large part due to mistakes of past management that have been rectified, and is poised to grow its EBITDA at high single digits for the foreseeable future. As the company continues to execute, we expect the multiple discount to its peers to shrink and the stock to rally 44% over the coming 6-18 months.   

Constellium was previously written about on VIC. For more background, below are links to the two prior reports:

(2017) https://www.valueinvestorsclub.com/idea/CONSTELLIUM_NV/140295

(2015) https://www.valueinvestorsclub.com/idea/CONSTELLIUM_NV/136926

* Note: Constellium reports its financial results in Euro, while also issuing debt instruments in Euro and USD. For clarity, since shares trade in USD on the NYSE, throughout this report all financial figures are in USD, including past results and our projections at the 1.24 EUR/USD rate. At times during the report, to remind readers of this, we note USD.

Description

Constellium (NYSE: CSTM) is a global designer and manufacturer of rolled and extruded aluminum products, primarily for the packaging, aerospace, and automotive end-markets. The Company operates manufacturing facilities in the United States, Europe, and China. Constellium creates value by converting aluminum into semi-fabricated products. Within its markets, Constellium produces differentiated and customized products that generate higher margins, compared to less differentiated or commoditized products. Constellium’s customer base includes: Rexam, Anheuser-Busch InBev, Ball Corporation, Crown Holdings, Airbus, Boeing, BMW AG, Daimler AG, and Ford Motor Company.

Capital Structure

Estimated year-end 2017 capital structure based on 4Q:17 debt and equity offerings.

*Euro converted to USD @ 1.24 EUR/USD

Key Markets

Constellium is a global aluminum rolling and extrusions manufacturer focused on three key markets that are complemented by niche products to fully optimize the company’s assets and production capacity.

The packaging business is a stable, low-growth, low-margin business, with demand that is highly resilient throughout economic cycles. In the can body market, Constellium has the #2 and #3 market shares in Europe and North America, respectively. Further, in the closure market, Constellium earned the #1 market share. Within this market, high value-added products include bottle cans, closures, and coffee capsules. For example, a beer can for Anheuser-Busch InBev.

The aerospace business is a mid-growth, high-margin business. During the past year this market experienced a de-stocking cycle with signs of stability emerging at year-end 2017. In the aerospace plate market, Constellium has the #1 market share worldwide, while in the aerospace sheet market, the company has the #1 market share in Europe. Within this market, high value-added products are airware, wingskins, and fuselage sheets. Currently, Airbus and Boeing enjoy multi-year backlogs and robust demand driven in large part by the growth of the global middle class in emerging markets, Asia, and the Middle East.

The automotive business is an emerging growth market with high margins, fueled by the trend of lightweighting of vehicles. For crash management systems, Constellium is tied for the #1 market share globally, while for auto body sheet tied for the #2 market share in Europe.  Demand for aluminum in vehicles is based on the demand and production of electric vehicles (EVs) and also from air quality regulations globally, such as CAFE standards in the United States and other national efforts in Europe, Canada, China, and Japan to reduce air pollution. In addition, there is growing secular demand for SUVs and safer cars, with aluminum rolled and extruded products providing solutions for light weighting and crash-absorption. Within this market, high value-added products are auto body sheet, structures, battery boxes, crash management systems, and heat exchangers. While EVs today represent about 1% of new global car sales (and 4% in China based on December 2017 data), EV growth rates are increasing rapidly and represent a multi-decade high growth opportunity.  

Source: Constellium Analyst Day Presentation, March 2017

Packaging & Automotive Rolled Products (P&ARP)

The company’s strategy is to grow its auto body sheet businesses in the United States and Europe with ramp-ups of new CALP lines. In addition, the company is optimizing its operations to more efficiently utilize capacity amongst canstock and auto body sheet, given the higher margin and higher growth of auto body sheet.  By 2019, Constellium expects to have full deployment of its Neuf Brisach (France) and Bowling Green (Kentucky) CALP facilities.

This segment represented approximately 53% of total revenue, in 2016. During that same year, 85% of shipments were for packaging while 11% were automotive, with the corresponding sales volumes 80% and 13%, respectively. Key automotive customers include Mercedes-Benz, Audi, GM, and Tesla. In mid-2014, Constellium acquired the Muscle Shoals facility and subsequently revamped its operational efficiency and production, yielding stronger productivity.

During the first 9 months of 2017, adjusted EBITDA (USD) per metric ton rose 1% to $254 while adjusted EBITDA was flat at $196mm, as improved price and mix from increased automotive rolled product shipments were offset by lower packaging rolled product shipments and incremental costs from the automotive readiness program rollout in the United States. During this period, shipments were down 1% to 770k metric tons, as the significant increases in automotive were offset by declines in packaging.

Aerospace & Transportation (A&T)  

The company’s strategy is to maintain aerospace shipments while increasing its share of value-added content with a renewed focus on the transportation, industry, and defense end markets.

A&T generated 27% of total revenue, in 2016. During that year, 51% of shipments were for transportation, industry, and defense end markets, while 49% were for aerospace. However, from a sales dollar perspective, 61% of sales were to aerospace and 39% to transportation, industry, and defense. Top customers include Airbus, Boeing, Bombardier, Embraer, and Lockhead Martin. Furthermore, 90% of Constellium’s aerospace sales were based on long-term contracts, which underscore the stability of the business despite fluctuations in the business cycle.

During the first 9 months of 2017, adjusted EBITDA (USD) per metric ton rose 23% (including 49% in 3Q:17) to $671, while adjusted EBITDA increased 22% to $123mm, owing to better pricing and mix and tight operating cost containment. Shipments declined 1% to 182k metric tons, as stronger transportation, industry, and defense shipments were offset by lower results from aerospace.

Automotive Structures & Industry (AS&I)

While this segment caters to the automotive, engineering, building and construction and other transportation markets (rail and shipbuilding), the core focus is automotive. To this end, the company has invested heavily to maintain its leadership in this space. For example, by 2019, Constellium plans to have its White, Georgia and San Luis Potosi (Mexico) automotive structures facilities fully operational.   

AS&I generated 21% of total revenue, in 2016. During this same year, 27% of shipments were automotive structures, 18% automotive extrusions, and 55% other. From a revenue perspective, 43% were automotive structures, 11% automotive extrusions, and 46% other. Thus, the automotive industry is the majority of this segment’s revenue. Key customers include Ford Motor Company, Fiat Chrysler, Audi, Volkswagen, General Motors, BMW, Jaguar, Daimler, and Porsche.

During the first 9 months of 2017, adjusted EBITDA (USD) per metric ton rose 5% to $632mm, while adjusted EBITDA jumped 13% to $114mm, with shipment growth and improved expense management. Shipments rose 7% to 180k metric tons, with stronger market demand particularly within automotive.  

Segment Level Revenue and EBITDA Mix ($ USD)

Source: Company filings; Proprietary estimates

Our Perspective

Automotive transformation drives demand and higher margins

Secular trends in the automotive industry are driving demand for aluminum auto body sheet, as well as structures and extrusions. With average fuel economy (CAFE) standards set to exceed 50+ miles per gallon by 2025, automotive manufacturers are now focused on aluminum frames for lighter weight cars and electric vehicles. Electric vehicles create less pollution, support energy independence, and generate higher energy efficiency. Concurrently, to further improve fuel efficiency and create space for new technologies in vehicles, OEMs are focused on producing lighter weight vehicles. As a result, there is a significant shift underway from steel to aluminum in the industry. Constellium is one of the key beneficiaries of this evolution.

As the chart below illustrates, between 2010 and 2025 the amount of aluminum per vehicle is expected to rise more than 40% to 500+ pounds, mostly the result of auto body sheet and extrusions.

50 Years of Automotive Growth

Source: SAE International; Ducker Worldwide

In addition, as the chart below depicts, in North America, aluminum sheet for light vehicle body and closure parts will grow from less than 200 million pounds in 2012 to nearly 4 billion pounds by 2025.

Source: Ducker Worldwide

Given these macro trends, Constellium has invested heavily in the automotive market for rolled products and structures. For auto body sheet, management expects CAGRs of 19% and 12% in North America and Europe, respectively, from 2016 to 2021.

Source: Constellium Analyst Day Presentation, March 2017

Management is also optimistic about automotive structures across all product lines. As the slide below illustrates, Constellium has a dominant position in crash management systems with a 35% share, with expected double digit growth in Europe. In the North America market, body structures, chassis and battery boxes are expected to have double digit growth rates.

Source: Constellium Analyst Day Presentation, March 2017

Aerospace business near an inflection and next cycle will be higher margin

Despite a challenging past couple of years in the aerospace market, mostly due to destocking, Constellium has re-gained market share through stronger execution under new management and by benefiting from competitors having to manage operational issues. The destocking cycle, based in part from decreases in wide-body build rates, has stabilized in recent months. Further, we think that the significant backlog at OEMs is a critical data point for a positive outlook for the aerospace market over the next two to three years. Nonetheless, to further underscore how attractive is Constellium’s potential to continue expanding EBITDA, overall guidance is for high single digits growth, even without aerospace restocking despite the industry backlog at near record highs.

Further, Constellium is now strategically focused on high value-add aerospace products. For example, the company has more than 300 patents, including for Airware. Developed cross-functionally with engineers, operations, and sales teams along with customer input, Airware is among the industry’s most advanced solutions for aircraft structures, featuring aluminum, copper, silver, and lithium to lower density, increase stiffness, and build damage tolerance. Airware is already deployed with Airbus and Bombardier, as the material of choice for military and space applications.

Source: Constellium Analyst Day Presentation, March 2017

Strategic moat provides insulation from competitive threats

In the auto body sheet market, Constellium benefits from significant barriers to entry, based on its investments to date in its Neuf-Brisach (France), Bowling Green (Kentucky), and Muscle Shoals (Alabama) facilities, rolling capacity, vertical integration for access to production inputs (specialized alloys), and skilled labor.  Further, there is significant time investment for a facility to be fully functional. Even after a facility is permitted, built and operational (a multi-year process), an additional three to five years is required for a plant to receive certification to supply automotive and aerospace markets.

For example, in 2017, Braidy Industries announced plans to build a state-subsidized $1.3 billion aluminum rolling mill near Ashland, Kentucky with construction beginning in the first quarter of 2018. While improbable, this plant would become the first US greenfield aluminum rolling project in over fifty years. To succeed Braidy would have to secure financing, local approvals, tax benefits, and hire skilled workers (that are in short supply and not native to the location of the plant). Then sometime in 2023-2025, Braidy would be positioned to supply auto and aerospace OEMs. Given forecasts for auto body sheet demand growth, this development is unlikely to impact the timing of CSTM's second CALP line at Bowling Green and falls outside of our investable timeframe.

New management is transforming the company with renewed strategic and financial discipline

Up until mid-2016, Constellium was mismanaged with poor execution and minimal investor relations efforts. Management was based in Europe, despite significant operations in North America, and levered up the company’s balance sheet, especially with the overpriced acquisition of Wise Metals. Further management consistently over promised and under delivered.

In July 2016, the company appointed Jean-Marc Germain as CEO. Earlier in his career, Germain held senior executive roles in the aluminum industry with Pechiney, Alcan, and Novelis. Further, he has experience at Bain & Company and GE Capital. Essentially, Germain came aboard as a turnaround specialist. A few months later, Constellium hired Peter Matt, formerly of First Boston/Credit Suisse, as CFO to improve the balance sheet and improve financial efficiency.  

During the past year plus, with the Germain-Matt team, the stock has more than doubled, as management has executed on its strategic plan, improved the corporate culture, and de-levered the balance sheet. Investor sentiment has begun to turn positive with stronger management credibility, albeit the stock remains at a significant and unwarranted discount to its competitors. We expect this discount to compress as management continues executing on its turnaround.  

Packaging business brings stability during business cycles

The packaging business, while unexciting, is advantageous for its resiliency even during business cycle downturns. Further, with management’s focus on efficiency and productivity, we think there is room for margin improvement. Moreover, Constellium has significant competitive advantages which could enable the company to gain market share. These factors include its recycling facilities, efficient operations, and logistics network. The charts below demonstrates how the can stock business performed during the 2007-2011 economic downturn in both North America and Europe.

Source: Constellium Analyst Day Presentation, March 2017

Financials

*All figures in USD $ based on EUR/USD 1.24 rate

With management’s renewed focus on expense management and productivity gains, we project that adjusted EBITDA growth will exceed top-line revenue growth for the foreseeable future. In addition, we expect strong free cash flow growth (before growth cap-ex), given strong tailwinds in the automotive space and cost controls. Moreover, 2019 represents the end of a multi-year growth cap-ex spend for CSTM positioning the company into 2020 and beyond to generate prodigious free cash flow, while enjoying long term contracts and low cap-ex requirements.  

To reiterate our earlier discussion of the new management team, Peter Matt, CFO, is focused on cost reductions across the business, including corporate, manufacturing, procurement, technology, and asset optimization. We project that recent debt re-financings are likely to save approximately $40mm in annual interest payments.

Valuation

On an EV/EBITDA basis, Constellium trades at 7.7x our 2017, 7.1x our 2018, and 6.3x our 2019 estimates.

Kaiser Aluminum (KALU) and Arconic (ARNC) are the closest competitors in the equity markets. Both of these stocks trade at 9.6x 2018 and 8.7x 2019 consensus EBITDA estimates. As discussed earlier, Constellium is somewhat of a show me story due to prior management missteps, however, a discount of more than 2.5 turns, is unjustified. By applying an 8x multiple to our 2018 and 2019 EBITDA estimates, we derive a $19 average price that implies 44% upside.  

Stock Price Sensitivity Based on 2019 EBITDA

Stock Price Change Sensitivity Based on 2019 EBITDA

Risks

Execution of growth projects. As experienced in 2017, Constellium’s rollout of the first CALP line in Bowling Green was met with some delays due to supply chain logistics. We are confident that CSTM has learned from this and will avoid a repeat occurrence.

Loss of key customers. We believe this risk is mitigated by the company’s long-term contracts for key product categories, as well as overall customer portfolio management practices and programs to ensure customer satisfaction.

Metal pricing and currency exposure.  Constellium hedges these risks, including with contract management and close monitoring of these trading markets.

Conclusion

As one of only four auto body sheet producers in the United States (the others are Novelis, Arconic, and Aleris), Constellium is uniquely positioned for significant growth over the next five years as demand inflects upward for aluminum solutions for vehicle lightweighting. In addition, Constellium is poised to benefit from the near record level backlog in the aerospace industry which is likely to return to restocking activity by late 2018. In addition to these top-line revenue drivers, Constellium will also benefit from a renewed focus on financial discipline through tighter expense management and a strengthening balance sheet. The company trades at an unwarranted discount to comps and is poised to close the valuation gap with its peers as it completes its cap-ex cycle, executes on its plan, and continues to de-lever. At the average implied price at 8x our 2018 and 2019 EBITDA estimates, CSTM shares would trade at $19, representing 44% upside from present levels.  

Catalyst

Second CALP line at the Bowling Green facility. We expect an announcement in 1H:2018 once long term contracts are inked with major customers.

New contracts with OEMs for auto body sheet. New auto sheet business represents the company’s most significant growth driver for the next 5+ years. We expect additional announcements in 2018 and beyond.

Aerospace restocking cycle. Our base case is for the aerospace market to be stable in 2018 (compared to 2017 destocking cycle). With robust backlog and demand growth, risk is skewed to the upside.

Positive free cash flow. The company is completing a large, multi year cap-ex cycle in 2018-2019 after which it will remain with large, long term contracts and significant free cash flow.