Description

CSTM is an aluminum producer with exposure to the packaging, aerospace, defense, auto and general industrial sectors. The company has materially reduced leverage and raised guidance twice this year in a very tough environment despite two major end-markets operating well below normal levels. Investors have been rewarded with a stock that is down ~20%+ on the year and multiple compression. Macro headlines and European energy availability/concerns have weighed on the stock but the damage is too severe. The CSTM mgmt team has executed extremely well over the past few years, is focused on all the right metrics and data and has conservatively established 2025 targets that I believe have a decent chance of materializing a year earlier than expected.

On 2022, CSTM trades at a 10% FCF yield, 7% unlevered FCF yield, 5.8x Adjusted EBITDA and will end the year at 2.7x Net Debt/Adjusted EBITDA. The recently announced 2025 targets (which include the impact of a short recession) imply FCF yields of mid-to-high teens and a TEV/Adjusted EBITDA multiple (including FCF) of 3.9x. Leverage at that time will be in the low 1.0x zone with FCF yields using maintenance capex in the mid-20s%. For referene, the 3.125% July 2029 Senior Unsecured Bonds have a 6.7% yield. Current liquidity is ~€900MM and CSTM should remain FCF positive even in a recession. 2022 Guidance was for Adjusted EBITDA of €600-€620MM but was raised to €640-€660MM and then raised again to €670-€690MM. FCF of €150MM+ was raised to €170MM+ during Q1 and was reiterated during Q2. Consensus was in the middle of these ranges each time guidance was set. 2022 has obviously been a difficult year with several issues and worries across the supply chain, inflation, labor, covid, war, energy etc…

CSTM operates a very diverse portfolio with decent secular drivers and growth ahead (source of the growth rates are CRU, Drucker, 2022 CSTM Analyst day).  Aluminum's sustainable and lightweight attributes are the foundation of this growth. Roughly 70-75% of the business is recession resistant.

-          Packaging – 43% of 2021 revenue and forecasted aluminum sheet/plate growth of 4-5% through 2025.

-          Auto – 26% of 2021 revenue and forecasted aluminum sheet/plate growth of 11-15% through 2025.

-          Aerospace – 25% of 2021 revenue and forecasted aluminum sheet/plate growth of 13-15% through 2025.

-          Specialties – 25% of 2021 revenue and forecasted aluminum sheet/plate growth of 3-5% through 2025.

Clearly, the European energy supply and cost worries are a risk. CSTM has very solid pass-through contracts to deal with inflation. This has been detailed and is evident in their results over time. Of course, there could be a mismatch of timing in a random quarter but overall, inflationary impacts are well considered and managed. Mgmt has openly noted that they are working on energy surcharge mechanisms with their customers which they fully expect to recover. Energy is purchased on a rolling twelve month basis and CSTM is already realizing energy costs that are 100% higher in the P&L in 2022 vs. the prior 3 year average of €130MM. European energy availability is definitely a worry but I also view these impacts as most likely temporary in nature. The winter energy situation across Europe is expected to be very difficult, a dynamic which has been discussed daily since even the weeks ahead of Russia’s advance into the Ukraine. This is not an unknown issue and every European country is focused on doing whatever it takes to overcome/mitigate the problem. Germany, as an example, is ramping up storage (which is now at ~80% and the country is targeting 95% by early October), prioritizing coal shipments on its railways, working to find alternative energy sources with some success, canceling the closure/possibly reopening nuclear facilities to name a few initiatives. Europe is now ahead of schedule to exceed its 80% gas storage target in September. On CSTM’s Q2 earnings call, mgmt detailed some of the exposures and there was a lengthy discussion on this topic. Specifically, the CEO noted that “while we do have exposure to some countries that depend heavily on Russian gas, a substantial amount of our EBITDA in Europe is generated in countries with less dependence. In addition, we believe a 15% reduction in gas supply would lead to much less than a 15% reduction in our production capacity….we hope we don't have to use our contingency plans, but we are ready and we are not looking at it in a panic mode at all, and I think to the extent it's a 15% reduction it's very manageable.” Mgmt noted that gas flows from Russia to Europe in June were at 30% of the 2016-2021 average so the countries are already experiencing a lot of the expected pressure. Seasonally, the more important quarters to the CSTM annual result are Q2 and Q3 which I think favorably aligns with the worry here. At the same time, during Covid, CSTM was deemed an essential business/critical sector which I also think helps the cause. I am concerned about the impact on customers and the broader economic impact but I think a better situation will materialize the following year as countries have more time to adjust to the situation.

Still, this chart below from Berenberg highlights the current winter dynamic “scenarios for EU storage levels”. Note that 20% is considered the safety margin necessary to deal with unusual cold spells so rationing is a possibility. 

There is obviously headline risk in the short-term but from a medium to long-term perspective, I believe the market has given us a significant opportunity to accumulate CSTM’s stock at an attractive entry point. 

Thesis

o   Covid has really hurt the Aerospace segment as ~€100MM plus of Adjusted EBITDA has been lost and will eventually return. Mgmt noted they expect Aerospace market to fully recover by 2024 (commentary on the Q4 ‘21 call implied they expect to recover faster than the industry). Q1 and Q2 certainly showed progress here as shipments and segment Adjusted EBITDA were up decently yoy. On the Q2 call, mgmt still described the recovery in the early innings and noted that major OEMs have announced build rate increases.

o   Cost saves will continue. The €75MM cost saves were achieved a year ahead of 2022 and there are more initiatives to come.

o   Cheap valuation across several metrics.

o   Public LBO with manageable debt maturity ladder (the first maturity of €841MM is due in 2026 and then €309MM is due in 2028) and ample liquidity and FCF as noted above.

o   Mgmt team is focused on FCF and has been executing well.

o   Significant replacement value protection (replacement value is €9B+ vs. a TEV of €4.1B).

o   Energy and macro worries are a concern but I believe will be more temporary than appreciated and less impactful.

o   Beverage contracts were restructured over ’21 and ’22 and the environment in the US is more favorable than ever. Double digit price increases are tens of millions of incremental Adjusted EBITDA. Commentary on the quarterly earnings calls and from industry players overall has been very supportive here. The benefit will continue into 2025+ and visibility is solid out to 2030. CSTM’s largest end-market is also the most recession resistant.

o   CSTM is rapidly approaching its long-term leverage targets of 1.5x-2.5 and capital deployment to shareholders should ramp up at that time.

CSTM is compelling risk reward at current prices. Aerospace and Auto are still underperforming their potential because of temporary factors and mgmt analyst day targets would be almost achieved with just aerospace recovering. The long lead time Aerospace industry commentary and mgmt results and outlook have been encouraging as Q2 certainly showed a material step function in the segment’s recovery. CSTM has ample liquidity, a favorable maturity ladder, strong mgmt and the majority of the business is recession resilient. I believe the stock is at least a double from current levels. 

Catalyst

Execution

Aerospace recovery

Energy crisis settles down

Capital deployment