Weekend stock market update

A chemical company pitch and I guess we like the EU again

In 2023 one of my top convictions was for Celanese (CE) to hit 180 within a year when the stock was stuck between 100 and 110. It had recently closed on buying the M&M division of DuPont and that flow through of extra eps was going to push projections up to 18 - 20 in EPS. It historically trades at 9x to 10x, so hence, 180 PT. Sure enough in Q4 2023 it was off to the races, hitting north of 170 repeatedly, and even hitting 180 a few times outside of regular hours.

I exited my trading position, as the risk reward shifted toward balanced, and left my long term shares that I’d owned since 2015. Knowing that CE, as a materials company is cyclical in nature might under preform the next few quarters management had enough of a track record that when they said the future (1 - 2 years out) was bright I trusted them and mostly ignored daily price action.

What management didn’t tell us was that the bright future was based on their prayers of lower interest rates quickly. As their M&M purchase was financed with a lot of short term debt that was starting to come due in late 2024. Well interest rates didn’t fall, the macro still wasn’t great enough for the company’s earnings to inflect higher and so management had to cut the dividend by 90% and eat a lot of crow about their failures.

The stock reacted horribly. As a cyclical, you need to have a solid growing dividend for longer term shareholders to tolerate the drawdowns. Without it, there are better opportunities even within the same space.

Taking a step back for a second we need to talk about management. Celanese’s (now former CEO) Lori Ryerkerk was considered one of the best in the industry excluding the last 6 months of her tenure. She was so well respected that when Buffett bought in to CE in Q1 2022 the rumor was it was to recruit her to run Berkshire’s lagging chemical business.

Her mistake was trying to grow the business via huge M&A into a cyclical slowdown. One that seems apparent in hindsight, but at the time no one could’ve foreseen the damage China was about to have done to its economy, lowing the value of chemicals world wide. Adding to her pain was that DuPont mismanaged the M&M division as it was on the way out the door, leading to some not great medium term contacts, the took CE some time to unwind. Doing so only in time to see the bottom of the market. Lowering the value of the purchase and causing some of the expected cash flow needed to help recoup the purchase to vanish, further stressing the business.

Make no mistake the purchase was bad and Lori should be blamed for it, but about 20 - 30% of the problems were completely out of her control.

So Lori ‘retired’ at the end of 2024. You don’t survive the stock shock she had overseen very long. Especially when the shock is a direct result of her own actions.

The new CEO further talked down the near term inflection in their Q4 call, his first as CEO. As an aside he seems mostly fine but less memorable and more MBA graduate than Lori, who was always passionate about various parts of the business. He did have some bullish points, more on these below, but broadly wanted to stress the near term picture for CE was going to be challenging, especially with how bad the EU, ASEAN, and China looked coming out of the end of the year.

CE trades at <3x EBIDTA of 2024’s 2.4b number (but again heavy debt load so its closer to 7.5/8x EV/EBIDTA). In 2024 they did just over 500mm in FCF. Management thinks they will be able to beat that number in 2025. Probably likely, as they have more than 100mm in inventory right now that can easily be sold into the market the moment either price picks up or demand does. This should easily help spike FCF, but not on a sustainable level. In addition to that, they are also trying to pull 300mm~ of costs out. This should flow directly to EBIDTA and FCF if its successful. So its not unthinkable to say they’re going to clear 600mm of FCF on a 6b~ market cap company. Putting them at a 10% yield. Above their historic number. Again, with the debt on their EV its only a 3.33% FCF yield. Which is low for its sector.

Regarding their debt over the past two years they’ve paid down more than 2b, and want to keep that pace up. Assuming the same EV number, this should move 600 - 700mm to shareholders from debt holders. Or 10%~ upside from here. Adding in the FCF increase and moving the yield down to 8% pushes the stock up to a 70ish dollar price. Plus at 1x~ book on a forward looking basis any more downside should get bought up.

The Q4 earnings weren’t that bad, but they weren’t good enough to push the stock higher. This is important, because the move down was likely due somewhat to market participates understanding that it was on the short list to leave the index. Sure enough it left on Friday, what was interesting is that the stock moved higher after it was announced. Not a lot, a few pennies but still. Clear signs that there aren’t many sellers left in the name.

Over the last year the stock is down more than 65% off its highs. Slicing through every volume level imaginable, back to 2011 level nodes.

This 55 level is large. You can see it on the above all time chart. Multiple years bottomed here, 2011 topped here, and this was where the bottom was found in covid as well. Again, 1x book. Adding in the fact that we now got a debt led stimulus to focus on infrastructure and defense by the eurozone, and China is doing a consumer lead stimulus you have an environment where materials might suddenly matter again. This is the upside bull case to CE (and the prior written up Dow). It wasn’t surprising that the market bid both of them up 10% on Wednesday and Thursday after the EU and China news broke. They’re incredibly cheap and huge upside if the stimulus is able to revive both of their economies.

That’s also the primary bear case, if you’re a believer that the stimulus won’t work, that the EU zone and China will continue being terrible economical, then this write up should be ignored.

The chart also looks terrible. I would like to see it hold above 55 for at least a week before getting very excited as a long, but I believe upside to 65+ maybe even as high as 80 by EoY is possible. With a down side get out level of 50, the risk reward is 2:1 at the low end, possibly as high as 7:1 if it gets to 80. I’m long a long-term position from 2014 that is currently underwater and a much larger trading position that I bought at 53 while I was in Japan. I will either sell at 50 for a loss, or when it starts to look exhausted north of 65.

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While Celanese is no longer part of the gang of 493, it is a Glocal company. These companies have been hard to own since 2022 as they depend on the global economy growing to fuel growth. Not just money flows domestically. If the Eurozone/China get going, it won’t just be CE and DOW that rip, but a lot of other forgotten names. This dovetails well with what Scott Bessent said about the Trump Call thesis earlier this week. He wasn’t talking about the S&P 500 market cap weighted index, but the entire economy/broad index. We can use RSP as a proxy. If the Russian Ukraine war ends and the middle east settles down to normal levels of crazy and the Eurozone is embracing debt, Glocal companies are going to rip. Going from inflation level growth to GDP + inflation+ 2 - 4% extra growth, and absolutely sending these stocks. Nestle is another example. But there are many others. Something to keep in mind as well move forward into the second half of the year.

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One quick house keeping note. I find the broad market somewhat boring right now, as its just in deleveraging mode. There’s not much in the way of earnings coming up either. So if you’re a paid substack member put a company or chart down in the comments below that you want me to look at. I’m going to do a video for either Sunday afternoon or Monday morning on YT going over all of them.

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Back to the Eurozone, let’s talk defense stocks. I’m not a believer in many of the euro defense stocks as a broad basket. Mostly because many homes purchased in the Eurozone are done on float rates, and with increase debt comes higher rates, meaning mortgages will go up. This in turn will put political pressure on elected officials. So something will have to give. My assumption is it will be their extremely high regulatory environment.