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The Chemours Co (CC)

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Key Thesis: Leading market positions in high-quality product tiers + dedicated distribution infrastructure and resulting in cost advantage + using tech and R&D to achieve efficiency advantages. Market incorrectly treats it like a typical chemical company.

The Chemours Company is a chemical company that was spun off from former parent, DuPont, in 2015. It is a market leader in titanium technologies, fluoro-products, and chemical products (sulfuric acid and sodium cyanide)… with brand-name products like TEFLON, Ti-Pure, Krytox, Viton, Opteon and Nafion. These products (ingredients) are used in plastics and coatings, refrigeration and air conditioning, mining and oil refining operations, and in general industrial manufacturing.

Business

The main business segments in 2018 (and 2017) are as follows: Fluoroproducts (43%), Chemical Solutions (9%), Titanium Technologies (48%). No single customer represents more than 10% of Fluoroproducts and Chemical Solutions. Top 10 customers for Titanium Technology segment make up 35% of segment’s sales. Moreover, one customer represented >10% of this segment’s sales. Chemours also constantly focuses R&D heavily.

Fluoroproducts: Global market leader. Complex production creates high entry barrier. Divided into fluoropolymers (distinctive brands like Teflon and Viton with unique properties in coatings, lubricants and other applications) and fluorochemicals (leading position in ozone-safe HFC refrigerants under the “Freon” brand and environmentally-sustainable patented technologies like “Opteon” in refrigerants and cooling devices). Fluoroproducts demand grows with GDP – and might be higher when regulation leans toward more ozone-safe products. Supply chain is diversified (not just relying on China) and kept cost-competitive with contracts averaging 5 years. Chemours holds many patents in this segment that will expire from 2019 through 2034, and are believed to be of material importance to our business. However, no one patent makes or breaks the segment as a whole. Although Chemours has many competitors in this segment, Chemours believes it has a leadership position in fluorine chemistry and materials science, a vertically-integrated customer value chain, and deep customer knowledge.

Chemical Solutions: providing important raw materials to a wide array of industrial production sectors. Holds and licences leading process technologies (trade secrets) for hydrogen and sodium cyanide production, used in industrial polymers and gold production. Efficient distribution advantages in delivery to customers due to a robust network of logistic providers, and strategic geographical placement of production facilities. Customer loyalty locked due to long-term relationships with Chemours (DuPont) and excellent historical customer track record. Thus, there is stable sales with not much volatility.

Titanium Technologies: Chemours is the world’s LARGEST global producer of high-quality titanium dioxide (TiO2) pigments. These are used in coatings, packaging, building materials to deliver brightness, whiteness, UV protection, etc. Marketed under brand name “Ti-Pure”. PROPRIETARY chlorine-based pigment “Bai-Max” EXCLUSIVELY produced for customers in Greater China. Chemours is one of the few manufacturers using a chloride process – in which, gives it a cost-, efficiency-, and margin-advantage. Supply chain is also well-calibrated, as Chemours operates its own titanium mine in Florida since 1949. Chemours also sells the co-products such as calcined zircon to industries in US. Some important statements: “Demand is highly-correlated to growth in global residential housing, commercial construction, and packaging markets. In the long term, demand growth follows global GDP.” and “The products manufactured […] are not fully substitutable due to pigment quality consistency and pigment product design. We believe that the utilization of the premium performance manufacturing base is considerably higher than that for general purpose, lower- performance production.” Chemours is also planning to up-capacity using technology to reduce bottlenecks. While capacity is increased, Chemours also plans to ramp up on extending its mine and chalk up more long-term supplier contracts (most in Australia and Africa) to increase raw material supply. Costs are kept low and stable through requirement-based contract volumes and raw material sources are diversified among different suppliers to ensure highest quality at all times. Moreover, other peripheral raw material costs such as energy and chlorine logistics are kept down by having access to their own facilities and utilizing most efficient routes. As quoted, “Supply chain flexibility allows for ore purchase and use optimization to manage short-term demand fluctuations and provides long-term competitive advantage“. Its main competitors in this segment are Kronos Worldwide, National Titanium Dioxide Company, Tronox Ltd, Lomon-Billions Group… which Chemours says are fragmented, use the less-efficient sulfate process, and compete in lower-performance, general-purpose TiO2 market. Moreover, with regard to China’s growth in this space, Chemours says that it will be dampened by the “capacity shutdowns at marginal producers”. Customer sales are also pretty stable, with most on med-to-long-term contracts and strong customer relationships. TiO2 is subjected to sales seasonality. In addition, particularly in our Titanium Technologies segment, we hold significant intellectual property in the form of trade secrets, and, while we believe that no single trade secret is material in relation to our combined business as a whole, we believe that our trade secrets are material in the aggregate.

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Looking at the numbers-side of things now…We begin by taking a look at the basic revenue figures below. We discard 2015’s results because the spinoff happened mid 2015 – thus any “annual” figures reported for FY2015 will not be accurate. Starting from FY2016, we see that revenues and net profits have been consistently growing… which is a good sign!

We then take a look at the profitability measures.

ROE was close to a staggering 160% in 2017, and coming down to 100+% in 2018. This means that for every dollar amount of common stock, Chemours made at least the same amount for investors. Kind of incredible! We also see that ROIC is consistently at 20% – which indicates that even after accounting for debt, the business engine is running pretty well! ROA is also increasing above 10% – possibly indicating that they use their assets very well. To find out if they REALLY did well as compared to peers, let’s take a look at the benchmark comparisons!

Benchmark chosen was “S&P 400 Materials Sector GICS Level 1 Index”

In all aspects, we see that Chemours has outdone its overall competition. Not only that, it has managed to increase its measures from 2017 to 2018.

On the debt side, we want to make sure they don’t take on too much debts. Now, if we were to take a look at Chemour’s D/E or Debt Ratio… we would get a shock. D/E (2018) is almost 400 times while Debt Ratio is at a better (but still disconcerting) 54%. However, we take solace because this is what the “Materials” industry normally has – huge debts need to be made to carry out the expensive business processes of raw material logistics, energy usage and industrial production.

If you look at benchmark Debt-to-EBITDA, we see that Chemours has done relatively well 2017 onwards. The reason we use 2017 data onwards here is because we need to start assessing Chemours on a fresh state. The 2016’s results will still have deferred expenses and profits (and balance sheet items) from its time at DuPont in 2015 – which is not representative of the state of operations as an independent entity. For instance, if you look at D/E in 2016, you would see 3000+ times… which is quite ridiculous.

Okay, so let’s say we still are not satisfied with this “improvement” because we might think this Chemours’ peers may operate on a high-risk basis in general – which skews the benchmark results.

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No worries. Let us look at Chemours itself and whether it can cover its OWN liabilities – using the Interest Coverage Ratio.

According to Investopedia, we consider a ICR >3 to be adequately sufficient for a typical business. For Chemours, it definitely has managed to go beyond that in 2017 and 2018. This should give us confidence that Chemours will have no problems repaying its debts.

Last but not least, we like to look at CASH. Cash is definitely king – especially in a capital intensive business like Chemours. Looking at the Free Cash Flow (FCF) profile, we see that Chemours consistently generates positive Free Cash Flow. And in 2018, FCF rose to almost 650 million USD – definitely a good sign.

Relating it to stock market value, we also get FCF yield of 6.4% (2016), 2.5% (2017) and 12.9% (2018).

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Management

The president and CEO of Chemours is a Mr. Mark Vergnano, who has over 30 years of chemical industry experience at DuPont. We have no doubts about his competencies to lead Chemours’ growth – seeing how he has managed to drive such amazing quantitative figures above as compared to his competition!

Next, we want to find out if his (and the overall management’s) interests are aligned with shareholders.

Breakdown of Executive Compensation, Bloomberg

We look at the overall executive compensation structure for 2016 (when it first spunoff) and in 2018 (the most recent annual figure). Straightaway, we see that “non-equity incentives granted” shrunk quite significantly… and that stock and options awards grew.

This can definitely signal a positive alignment with shareholders – as management now has some skin in the game. However, the stocks and options granted might be contracted at a big discount that a typical investor cannot get. Moreover, exercising those options might mean value dilution for existing shareholders. However, seeing that majority of compensation comes from direct stock awards, we need not worry too much.

Valuation

The orange line indicates EV/EBITDA, while the grey line indicates FCF yield

We see from the above chart that Chemours has come down a whole lot in terms of historical valuation. As at FY18, Chemours trades at around 5x EV/EBITDA. If we look at trailing TTM PE, we get about 6x P/E. A highly desirable value stock.

Here’s what Chris McIntyre from McIntyre Partnerships had to say about the valuation and its mispricing:

“…market is substantially overestimating the cyclicality of CC’s earnings […] I believe the market is treating CC as a generic TiO2 producer, which ignores 1) CC’s significant cost advantage yields substantial profits even at cyclical bottoms and 2) half of CC’s EBITDA is generated from flouroproducts.

On cost advantage, CC has a substantial scale advantage as well as a proprietary process, un-cracked for 70 years, which results in an ~$300/ton cost advantage versus peers. For comparison, TiO2 peers average ~$300/ton in EBITDA-capex over a cycle.

On fluoroproducts, the segment is significantly less cyclical than TiO2 and has a strong growth driver in Opteon, its next generation refrigerant, which should drive high single-digit to low double-digit growth in the next few years.

There is much runway for growth for Chemours – especially since its market cap is only 6+ billion USD (mid-cap). This is the stock value investors would die for – a misunderstood stock that has been lumped with other generic chemicals stock… in an industry that’s not doing really well at the moment (it is more or less reaching a cyclical bottom).

We would initiate a LONG on this – and hold it for at least 3-5 years until the inherent value of its competitive advantages are realized.

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