Tuesday, May 31, 2016

Methanex Muscle

Methanex (MEOH:  Nasdaq) turned up in a recent stock screen of companies with strong dividend yields.  The current yield on MEOH shares is 3.4% since the company increased its payout by 10% last year.  Granted with a beta measure near 2.00, the shares may have more volatility than is unpalatable for some risk-averse investors.  Yet, with continued miserly interest rates on bank deposits, dividends have become an important option.

Among the largest producers of methanol in the world, Methanex operations deliver strong cash flows.   In 2015, the company converted 13.4% of sales to operating cash flow, delivering $200.1 million in free cash flow after capital expenditures for plant maintenance.  Double digit sales-to-cash conversion is always impressive.  However, recent performance is actually down compared to the previous year when the ratio was 24.9% and Methanex produced $716.8 million in free cash flow.
Cash flow generation is important keeping facilities in good working order.   It is also necessary for deleveraging the balance sheet.  The company paid down $194 million in debt in 2015.  By the end of the year Methanex had about $1.5 billion in debt outstanding, representing a debt-to-equity ratio of 80%.  That is well above the average of 34% for the rest of the specialty chemical industry of which Methanex is a part, making it clear that cash is critical. 
Methanex management made other capitalization decisions in 2015, repurchased $146 million in shares of its own common stock.  MEOH has sold off over the last few years, sinking to levels not seen since 2012 when the world economy was still trying to shake of the Great Recession.  Share repurchase is an alternative to a dividend as a means to deliver return to shareholders.  While shareholders receive no check, the entrance of the company into the market helps soak of supply and supports an undervalued stock.
Of course, reliability of cash flows is a factor in all dividend plays.  Methanex is very much at the mercy of the evolving character in the methanol market.  Although historically priced under its own dynamics, methanol has come increasingly under the influence of the crude oil market since the development of the methanol-to-olefins industry in China.    Industry analysts refer to this as the MTO market and it now represents the largest source of demand for methanol.  To put olefins into perspective, they are among simplest hydrocarbons and represent the basic raw material for plastics.  Olefins represent an $18 billion industry worldwide and, according to Grandview Research, is growing at about 6% per year through 2020. 

This development has drawn methanol producers into competition with conventional petrochemical ‘crackers’ that have been the historic feedstock suppliers to olefin producers.  As crude oil prices have declined naptha becomes a more cost-effective option in the olefin market.  The competition to grab customers with this very large source of demand effectively has put a ceiling on methanol prices.  It is an unusual situation for methanol producers when the feedstock (crude oil) for a substitute product (naptha) becomes a margin driver.  Of course, an improvement in olefin prices would provide some relief to methanol producers.  
Since natural gas is the primary feedstock for methanol, Methanex has benefited from shale gas expansion in the U.S.  By the end of 2015, company had ten plants in operation around the world with production capacity near eight million tons per year.  The company put several long-term feed stock arrangements into place in 2015 that should deliver margin improvement in the quarters ahead.  For example, Methanex is using forward contracts to hedge as much as 40% of the feedstock requirements for its largest production facility in Louisiana.  The company is also developing expertise in alternative feedstocks.  In 2013, Methanex invested in Iceland-based Carbon Recycling International, which uses plant emissions as feedstock for methanol production.  The liquid methanol is marketed in Europe for blending with gasoline.
Granted there is some risk in Methanex  -  both market risk with that ample beta measure and business risk with competitive pressures on selling prices.  Nonetheless, it appears there is rational operating structure that delivers cash flows.  This should give Methanex some muscle as it navigates both the peak and trough of the business cycle.  

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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