Friday, November 01, 2019
MEOH: Love-Hate Investment Case
Me mind on fire,
Me soul on fire
Feelin' Hot Hot Hot!
The world’s largest supplier of methanol, Methanex (MEOH), reported third quarter financial results earlier this week. The multi-continental operation recorded a $10 million net loss on $1.8 billion in total sales in the three months ending September 2019. The numbers were disappointing as about an equal level of production in the same quarter last year produced significantly higher revenue and profits. Declining methanol selling prices was cited as the primary cause of top-line erosion and shrinking profit margins.
What is management’s solution to flagging performance? Expansion! Methanex is building a third production facility in Louisiana next to two existing facilities. The location gives the company easy access to natural gas supplies and makes it possible to leverage existing operational and managerial talent. When the third facility comes online, production will be expanded by 1.8 million metric tons. Management also disclosed during the recent earnings conference call that a new natural gas source has been pinned down to supply the company’s Chile production facilities. The Chile plant is undergoing refurbishment.
Methanex leadership is likely taking a long-term view on methanol demand, seeing healthy trend into the future. Popularity of methanol-based transportation fuels is a key demand driver. Methanol is used as a gasoline component for internal combustion engines and methanol-fuel vehicles are gaining popularity in China. Industry research firm Research and Markets has predicted that the market for methanol could grow at an annual compound rate of 5.6% for the next five years. The forecast acknowledges that overall methanol demand is negatively impacted concerns for health and environment. The mixed news for methanol derives from its principal source - steam reformation of methane in natural gas.
The Methane Origins of Methanol
Composed of just one carbon atom and four hydrogen atoms, methane is the simplest of the hydrocarbons. Methane gas is colorless, has no odor and is not itself toxic. Boy does it burn! Methane burns easily in the presence of oxygen and generates between 50 and 55 mega joules of heat per kilogram. Not impressed? The heating fuel of choice for decades, coal, generates heat less than half as much heat - 20 mega joules per kilogram to 25 mega joules depending upon the type of coal. Crude oil and diesel fuel generates between 42 and 47 mega joules per kilogram.
The ‘Hot! Hot! Hot!’ nature of methane helps explain the popularity of natural gas for heating and electricity generation. Natural gas is about 90% methane with smaller amounts of other alkanes. The fact that natural gas costs less to produce than oil is just icing on the cake.
Unfortunately, methane has a dark side. It is among the worst greenhouse gases. According to the U.S. Environmental Protection Agency, in 2017 methane accounted for about 10% of greenhouse gas emissions from human-related sources. Methane is particularly worrisome as a greenhouse gas, causing an inordinate worry over methane gone errant in the atmosphere. Scientists have determined that a kilogram of methane warms the planet as much as 80% more than a kilogram of carbon dioxide.
Then there is thermal expansion. Methane along with other greenhouse gases creates heat, about 90% of which is absorbed by the oceans according to NASA. As a consequence the seawater expands in volume, elevating sea levels. At the turn of the century sea levels began rising about 3.2 millimeters per year (about one-eighth of an inch). This was up from a pace between 1.5 millimeters and 1.7 millimeters per year during the previous ten decades. Of course, glacial melt and shoreline decay also contributes to rising sea levels. Yet, NASA studies have demonstrated thermal expansion of oceans is having a significant impact on sea level.
Natural gas production contributes for about 31% of methane emissions in the atmosphere. Leaks from production pipes and deliberate venting to the atmosphere release methane into the air. Cattle and their ruminant cousins represent another major source or errant methane. Scientists call it enteric fermentation - the natural digestive process in animals with four stomachs where microbes breakdown plants for digestion. Cow belches and methane left over in cow poops contribute 36% of methane emissions. Coal mining (16%), landfills (9%) and other sources such as rice paddies and wetlands (8%) account for the rest.
The Trump Administration has recently tried to become a friend to natural gas producers. In late August 2019, Trump’s minions announced a rollback in rules intended to reduce greenhouse gas emissions from oil and gas production equipment. Interestingly, the largest producers of natural gas in the U.S. voiced opposition to the rule roll back as contrary to goals to create cleaner, environmentally sustainable fuels.
Love-Hate Investment Case
Perhaps Methanex shares large oil and gas views on greenhouse gas emissions. Like natural gas producers, the company benefits from a favorable view on the environmental friendliness of their product. Trump has also signaled intentions to withdraw from the Paris Accord sets forth goals to reduce greenhouse gas emissions. The merits of such a move for are uncertain given that most companies developing and producing derivatives of fossil fuel, including Methanex with its methanol product, have multi-national operations. If being able to offer an environmentally friendly product to the market is a priority, then locations in Asia or Europe or the Middle East may seem more appealing given continued support by countries in those regions for the objectives of the Paris Accord.
Putting aside ‘green branding’ priorities, shares of Methanex are trading at 14 times forward earnings. That may seem appealing to some investors against the company’s plans to expand. However, compared to projected earnings growth the stock price/earnings ratio may be concerning for some investors. The price/earnings to growth ratio or PEG ratio is 1.40, suggesting overvaluation.
There is also the niggling problem of methanol selling prices. Ample supply and increased production capacity are reportedly the cause of the drop in selling prices over the last year. Russia has been a big contributor to new supply that Europe has not been able to absorb. Furthermore, demand in Asia has been sluggish as the U.S.-China trade war goes into overtime. Industry analysts are pointing to continued weak pricing under these conditions. Valuation usually crumbs right along with weak selling prices.
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.