In late 2020, Vanguard changed this strategy’s prospectus benchmark from the MSCI ACWI Energy Index to the MSCI ACWI Energy + Utilities Index (a custom benchmark that splices the MSCI ACWI Energy and MSCI ACWI Utilities indexes). The firm made the change so this strategy could capitalize on the evolution away from fossil fuels and toward renewable energy sources by investing significantly more in electric and other utilities.
Portfolio
The MSCI ACWI Energy + Utilities Index is a dynamic benchmark, and its sector weights vary based on the performance of energy stocks versus utilities stocks. Meanwhile, the MSCI ACWI Energy Index gained 36% in 2021, whereas the MSCI ACWI Utilities Index returned 10% last year. The MSCI ACWI Energy + Utilities Index’s energy stake increased to 56% as of Dec 31, 2021, as result, while its utilities position decreased to 44% (per Vanguard data).
People
Tom Levering has good credentials for picking utilities stocks as well as energy equities. For starters, he spent several years as a utilities consultant before joining Wellington in 2000, and he served as an energy and utilities analyst for roughly two decades–and led Wellington’s combined energy/utilities team for a few years–before he took charge of this fund in early 2020.
Performance
The Investor share class of this strategy recorded a 27.7% gain in 2021. That’s significantly less than the 36.0% and 44.8% returns posted by the MSCI ACWI Energy Index and the average fund in the energy equity Morningstar Category, respectively. But this strategy is an energy/utilities hybrid that began 2021 with roughly 48% of its assets in utilities stocks and ended the year with roughly 44% of assets in such names, and the MSCI ACWI Utilities Index produced a gain of just 10.1% last year. The Investor share class’ 27.7% gain is significantly better than the 23.6% return of a 50/50 MSCI ACWI Energy/Utilities custom index and better than the 23.0% return of the strategy’s custom prospectus benchmark.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Norfolk Southern is a well-managed enterprise, and from the start of the rail renaissance in 2004 through 2008, it posted the highest margins among U.S. Class I railroads. However, its operating ratio (expenses/revenue) deteriorated to 75.4% in 2009 and remained stuck between 69% and 73% from 2010 to 2015. This pales in comparison to progress made by peers Union Pacific and Canadian Pacific, which lack Norfolk’s exposure to Appalachian coal. However, by 2017 the rail was back on track, and it has achieved record ORs in each year since, including an adjusted 60.1% in 2021. In recent years, Norfolk renewed its commitment to pricing discipline and margin gains, particularly via precision railroading initiatives, which have driven more efficient use of locomotive assets, labor, and fuel. It is anticipated incremental gains as the firm continues to refine its PSR playbook. Of note, in late 2019, former Canadian National CEO Claude Mongeau (2010-16) joined Norfolk’s board of directors in part to help bolster the rail’s PSR efforts.
Norfolk hauls coal directly from Illinois and Appalachian mines, and transfers Powder River Basin coal eastward from the Western rails. Thus, coal-demand headwinds and changes in environmental regulations will probably remain a factor over the long run, despite near-term improvement off lows posted in 2020. That said, coal runs in unit trains hauling exclusively coal (often using customers’ cars), thus it is believed that the rail can continue to adjust its train and crew starts to match demand conditions.
Norfolk generated healthy volume growth near 5% on average within its intermodal franchise over the past decade. In fact, intermodal revenue surpassed coal in 2014 and is now the highest-volume segment (roughly 60% of 2020-21 carloads versus 9% for coal). Capital projects targeting capacity and velocity improvement have helped the rail capitalize on net positive truck-to-rail conversion activity over the years. Norfolk’s domestic intermodal volume may face congestion-related constraints lingering into early 2022, but it is still seen as intermodal as a key long-term growth opportunity.
Financial Strength
At year-end 2021, Norfolk Southern held an ample $839 billion of cash and equivalents compared with $13.8 billion of total debt ($12.1 billion in 2020). Historically, the rail generates steady free cash flow, despite investing heavily in its network (capital expenditure averaged 16% of revenue over the past five years). Norfolk deploys this cash on dividends and share repurchases, and occasionally borrows to boost these returns to shareholders. Share repurchases eased briefly 2020 due to pandemic risk to cash flow, but they ramped back up by year-end, and it is held, repurchase activity to remain active in the years ahead. Norfolk Southern operates with a straightforward capital structure composed mostly of senior notes. In terms of liquidity, the rail also has an $800 million revolving credit facility and a $400 million accounts receivable securitization program for short-term needs–both programs are fully available and undrawn as of third-quarter 2021. In 2021, Norfolk’s total debt/adjusted-EBITDA came in near 2.5 times (2.7 times in 2020). It is projected 2.2 times in 2022. The historical five-year average is 2.4 times. Interest coverage (EBITDA/interest expense) was a comfortable 9 times in 2021, versus 7 times in 2020. Overall, Norfolk’s balance sheet is healthy and it is anticipated the firm will have no issues servicing its debt load in the years ahead.
Bulls Say’s
Norfolk Southern reignited operating ratio improvement in 2016 after stagnating over the preceding six years. With help from precision railroading, the rail reached OR records in each of the past four years.
Norfolk Southern runs one of the safest railroads in the U.S., as measured by injuries per hours worked; this boosts service levels and helps to keep costs down.
Compared with trucking, shipping by rail is less expensive for long distances (on average) and is four times more fuel-efficient per ton-mile. These factors should help support longer-term incremental intermodal growth.
Company Profile
Class-I railroad Norfolk Southern operates in the Eastern United States. On roughly 21,000 miles of track, the firm hauls shipments of coal, intermodal traffic, and a diverse mix of automobile, agriculture, metal, chemical, and forest products.
(Source: MorningStar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Defense prime contractors are not born, they’re assembled. L3Harris Technologies, the sixth-largest defense prime by defense sales, was made from the merger of equals between L-3 Technologies, a sensor-maker that operated a decentralized business focused on inorganic growth, and the Harris Corporation, a sensor and radio manufacturer that ran a more unified business. Underpinning the merger’s thesis was an assumption that additional scale would primarily generate cost synergies but that eventually, the firms would produce meaningful revenue synergies.
Defense primes are implicitly a play on the defense budget, which is thought to be ultimately a function of a nation’s wealth and its perception of danger. The fiscal stimulus used to support the U.S. economy during the COVID-19 pandemic dramatically increased U.S. debt, and higher debt levels are usually a forward indicator of fiscal austerity. But it is alleged, a flattening, rather than declining, budgetary environment as is seen, that heightened geopolitical tensions between great powers are likely to buoy spending despite a higher debt burden. It is thought contractors will be able to continue growing despite a slowing macroenvironment due to sizable backlogs and the national defense strategy’s increased focus on modernization, and it is believed defense budget growth is likely to return to its long-term trend.
Broadly, it is probable, with management’s thesis on the merger. Cost synergies to a large extent drove the 30-year wave of consolidation across the defense industry, which has largely generated shareholder value. Both L-3 and Harris had high revenue exposure to the defense sensors business and operated reasonably similar businesses, so it isn’t seen major execution risks in the merger. Arguably, L-3 was an ideal partner for a merger of equals because L-3 operated as a holding company and there are quite a few potential efficiencies from consolidating the firm into a more integrated firm. The three biggest firm-specific growth opportunities which are seen for L3Harris Technologies are the tactical radios replacement cycle, national security satellite asset decentralization, and international sales expansion.
Financial Strength
It is held, L3Harris is in solid financial shape. The firm increased debt by about $4.5 billion in 2015 to fund the acquisition of Exelis, a sensor-maker that was spun off from ITT and had been paying down debt since. The firm’s all-stock merger of equals with L-3 Technologies did not dramatically increase debt relative to size, and it is projected, a 2022 gross debt/EBITDA of roughly 2.0 times, which is quite manageable for a steady defense firm. The company is using the proceeds of portfolio divestitures for share repurchases, so it is anticipated EBTIDA expansion will be the driving force behind a decreasing debt/EBITDA over Analysts’ forecast period. While it is cherished the desire to compensate shareholders, it is likely that paying down debt may be more value accretive, as it would make more comfortable for analysts in decreasing their cost of equity assumption for the firm. While L3Harris has some exposure to commercial aviation (depending on definitions, roughly 5%-15% of sales), it is not anticipated the firm will be materially affected by the downturn in commercial aviation. As demand for defense products has remained resilient, it is not foreseen, for the firm needing to raise capital any time soon. That noted, L3Harris produces a substantial amount of free cash flow and is not especially indebted, so it is awaited that the company would be able to access the capital markets at minimal cost if necessary.
Bulls Say’s
There is substantial potential for cost synergies from the merger with L-3 due to the decentralized organizational structure of the pre-merger entity.
L3Harris is at the base of a global replacement cycle for tactical radios, which is likely to drive substantial growth.
Defense prime contractors operate in an acyclical business, which could offer some protection as the U.S. is currently in a recession.
Company Profile
L3Harris Technologies was created in 2019 from the merger of L3 Technologies and Harris, two defense contractors that provide products for the command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) market. The firm also has smaller operations serving the civil government, particularly the Federal Aviation Administration’s communication infrastructure, and produces various avionics for defense and commercial aviation.
(Source: MorningStar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
It is impressive, Charter’s aggressive effort to drive customer penetration by limiting price increases, improving customer service, and expanding its offerings to appeal to a variety of preferences. It is likely the firm will successfully navigate growing competition from the phone companies, though growth will likely slow in the coming years. Charter’s aggression extends to its capital structure, where heavy share repurchases have bolster shareholder returns but have also kept debt leverage high, which will likely add volatility to the share price and could limit financial flexibility.
Charter’s cable networks have provided a significant competitive advantage versus its primary competitors–phone companies like AT&T–as high-quality Internet access has become a staple utility. It is anticipated the firm now claims about 70% of the Internet access market across the territories it serves, up about 9 percentage points over the past five years and still marching higher. Charter has been able to upgrade its network to meet consumer demand for faster speeds at modest incremental cost while the phone companies have largely ignored their networks across big chunks of the country. Phone companies, notably AT&T, are starting to increase fiber network investment, which is projected will hit Charter at the margin–the firm has faced less fiber competition than its major cable peers. However, it is held Charter will remain a strong competitor even when faced with improved rival networks.
Wireless technology has emerged as a potential new competitor to fixed-line Internet access. Analyst’s sceptical of wireless’ ability to meet network capacity on a wide scale for the foreseeable future. Also, it is likely dense fixed-line networks like Charter’s will play an increasingly important role in powering wireless networks in the future. Charter also faces declining demand for traditional television services, but here again it isn’t seized investors should be concerned. The amount of profit the firm earns from television service has been declining for several years. Internet access, now the bedrock of Charter’s customer relationships, delivers the vast majority of cash flow today.
Financial Strength
Charter operates under a fairly heavy debt load, with net leverage standing at 4.6 times EBITDA, by analysts’ calculation, a level that has held steady in recent quarters. Charter’s management team has run with a net leverage target of 4.0-4.5 times EBITDA over the past several years, typical of firms under the influence of Liberty and John Malone. By the firm’s calculation, net leverage was 4.4 times EBITDA at the end of 2021. This debt level is higher than its peer Comcast, which has typically targeted net leverage of around 2.0-2.5 times EBITDA. On the other hand, Charter’s leverage is more modest than Altice USA’s at roughly 5.5 times EBITDA. Charter typically directs free cash flow and the proceeds from incremental borrowing to fund share repurchases as a means of keeping leverage within its target range as EBITDA grows. The firm believes that it could reduce leverage quickly if its borrowing costs or business outlook change materially in the future. The firm generated free cash flow of about $8.7 billion in 2021 and spent $17.7 billion repurchasing shares and partnership units held by Advance/Newhouse. As a result, net debt increased to $91 billion from $82 billion at the start of the year. Importantly, free cash flow will face headwinds in the coming years as Charter begins paying federal taxes, which are likely to be meaningful starting in 2022. Charter has actively managed its debt load in recent years, trimming interest rates and pushing out maturities. About $7.5 billion of debt comes due through 2024 and its weighted average maturity stands at about 14 years at an average cost of 4.5%.
Bulls Say’s
Like its cable peers, Charter’s networks provide a platform to easily meet customers’ growing bandwidth demands, which should drive market share gains and strong recurring cash flow.
As the second-largest U.S. cable company, Charter has the scale to efficiently adapt to changes hitting the telecom industry. The firm will be a force in the wireless industry eventually.
Holding prices down to drive market share gains will pay huge dividends down the road, pushing costs lower and cementing Charter’s competitive position.
Company Profile
Charter is the product of the 2016 merger of three cable companies, each with a decades-long history in the business: Legacy Charter, Time Warner Cable, and Bright House Networks. The firm now holds networks capable of providing television, Internet access, and phone services to roughly 54 million U.S. homes and businesses, around 40% of the country. Across this footprint, Charter serves 29 million residential and 2 million commercial customer accounts under the Spectrum brand, making it the second-largest U.S. cable company behind Comcast. The firm also owns, in whole or in part, sports and news networks, including Spectrum SportsNet (long-term local rights to Los Angeles Lakers games), SportsNet LA (Los Angeles Dodgers), SportsNet New York (New York Mets), and Spectrum News NY1
(Source: MorningStar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Dr. Reddy’s Laboratories is a global pharmaceutical company based in Hyderabad, India. It manufactures and markets generic drugs and active pharmaceutical ingredients in markets across the world, but predominantly in the United States, India, and Eastern Europe. Indian pharmaceutical manufacturers have seen success over the past decade in penetrating the U.S. market, where regulatory hurdles are lower than in Western Europe. With competition on price in a commodified space, the entry of low-cost manufacturers has facilitated a deflationary price environment for generic drugs since 2015, putting substantial pressure on the margins of established manufacturers. Conversely, in India and other countries with lower generics adoption, so-called “branded” generics have seen notable success.
Generic manufacturers have taken different approaches to combat margin pressure over the past few years. While some manufacturers have addressed competition by rationalizing their U.S. portfolio and discontinuing low-margin or unprofitable drugs, Dr. Reddy’s has remained focused on expanding its U.S. market share. While its U.S. portfolio has experienced marginally higher deflation compared with peers, its pipeline is increasingly leaning toward injectables and other complex generics that command higher margins and exhibit relatively more price stability.
Financial Strength
Overall, Dr. Reddy’s reported a relatively uneventful third quarter, with higher revenue across the board largely due to new product launches and market share gain. The company’s revenue grew 8% to INR 53.2 billion ($715 million) on a year-over-year basis driven by new product launches and higher sales volumes in the global generics business. North America generics, which represents the largest share of company revenue (35%), was positively affected during the quarter by launches for four new products but negatively impacted by erosion within in generic drug portfolio. On a sequential basis, revenue fell 8%, largely due to price erosion in generics and reduction of volume of COVID-19-related products.
As of the fourth calendar quarter of 2021, Dr. Reddy’s holds gross debt of INR 28 billion ($370 million), which is more than offset by the cash on the company’s balance sheet. With very low leverage, the company faces little liquidity risk. This compares favorably with other global generic manufacturers like Teva and Viatris, which are saddled with high leverage as a result of an aggressive acquisition strategy over the past decade. The company pays an annual dividend of $0.34 per share, which translates to a dividend yield of under 1%.
Bulls Say’s
Dr. Reddy’s low-labor-cost operations based in India and vertical integration likely provide a low-cost edge.
In the U.S. and Russia, Dr. Reddy’s has grown quickly in OTC generics, which is an attractive segment of the market with slightly higher barriers to entry than conventional retail pharmacy drugs.
Dr. Reddy’s strong branded generic presence in emerging markets provides significant growth opportunities with less price competition than typically seen in developed markets.
Company Profile
Headquartered in India, Dr. Reddy’s Laboratories develops and manufactures generic pharmaceutical products sold across the world. The company specializes in low-cost, easy-to-produce small-molecule generic drugs and active pharmaceutical ingredients. Its drug portfolio in recent years has included biosimilar drug launches in select emerging markets and has shifted toward injectables and more complex generic products. Geographically, the company’s sales are well dispersed across North America, India, and other emerging markets.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Caterpillar will continue to be the leader in the global heavy machinery market, providing customers an extensive product portfolio consisting of construction, mining, energy, and transportation products. For nearly a century, the company has been a trusted manufacturer of mission-critical heavy machinery, which has led to its position as one of the world’s most valuable brands. Caterpillar’s strong brand is underpinned by its high-quality, extremely reliable, and efficient products. Customers also value Caterpillar’s ability to lower the total cost of ownership.
The company’s strategy focuses on employing operational excellence in its production process, expanding customer offerings, and providing value-added services to customers. Since 2014, Caterpillar has taken steps to reduce structural costs and its fixed asset base by implementing cost management initiatives and by either closing or consolidating numerous facilities, reducing its manufacturing floorspace considerably. Over the past decade, the company has continually released new products and upgraded existing product models to drive greater machine efficiency. Customers also rely on the services that Caterpillar provides, for example, machine maintenance and access to its proprietary aftermarket parts. Furthermore, its digital applications help customers interact with dealers, manage their fleet, and track machine performance to determine when maintenance is needed.
Caterpillar has exposure to end markets that have attractive tailwinds. On the construction side, the company will benefit from legislation aimed at increasing infrastructure spending in the U.S. The country’s road conditions are in poor condition, which has led to pent-up road construction demand. In energy, the improvement in the price of oil since COVID-19 lows will encourage exploration and production companies to increase oil and gas capital expenditures, leading to increased sales of Caterpillar’s oil-well-servicing products. That said, it is believed mining markets will have limited upside, as fixed-asset investment growth in China starts to slow, likely capping commodity price upside.
Financial Strength
Caterpillar maintains a sound balance sheet. On the industrial side, the net debt/adjusted EBTIDA ratio was relatively low at the end of 2021, coming in at 0.2. Total outstanding debt, including both short- and long-term debt was $9.8 billion. Caterpillar’s strong balance sheet gives management the financial flexibility to run a balanced capital allocation strategy going forward that mostly favours organic growth and returns cash to shareholders. In terms of liquidity, the company can meet its near-term debt obligations given its strong cash balance. The company’s cash position as of year-end 2021 stood at $8.4 billion on its industrial balance sheet. It is comforting to find comfort in Caterpillar’s ability to tap into available lines of credit to meet any short-term needs. Caterpillar has access to $10.9 billion in credit facilities for the consolidated business (including financial services), of which, $2.9 billion is available to the industrial business. Caterpillar’s focus on operational excellence in its industrial operations and improved cost base has put the company on better footing when it comes to free cash flow generation throughout the economic cycle. The company can generate $6 billion in free cash flow in our midcycle year, supporting its ability to return nearly all its free cash flow to shareholders through dividends and share repurchases. The captive finance arm holds considerably more debt than the industrial business, but this is reasonable, given its status as a lender to both customers and dealers. Total debt stood at $28 billion in 2021, along with $27 billion in finance receivables and $826 million in cash. In our view, Caterpillar enjoys a strong financial position supported by a clean balance sheet and strong free cash flow prospects.
Bulls Say’s
Increased infrastructure spending in the U.S. and emerging markets will lead to more construction equipment purchases, substantially boosting Caterpillar’s sales growth.
Higher fixed-asset investment growth in China strengthens support for increased investment in mining capital expenditures, benefiting Caterpillar.
A continued recovery from the temporary demand shock in oil prices will lead to increased oil and gas capital expenditures, leading to more engine, transmission, and pump sales for Caterpillar.
Company Profile
Caterpillar is an iconic manufacturer of heavy equipment, power solutions, and locomotives. It is currently the world’s largest manufacturer of heavy equipment with over 13% market share in 2021. The company is divided into four reportable segments: construction industries, resource industries, energy and transportation, and Caterpillar Financial Services. Its products are available through a dealer network that covers the globe with over 2,000 branches maintained by 168 dealers. Caterpillar Financial Services provides retail financing for machinery and engines to its customers, in addition to wholesale financing for dealers, which increases the likelihood of Caterpillar product sales.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
The strategy rests on a solid philosophy and a clearly designed and consistently applied bottom-up process. The ability to leverage the analysts’ insights through both long and short positions makes it distinctive, though small active bets make us somewhat cautious regarding its alpha potential. The strategy aims to capture temporarily mispriced opportunities through consistent use of the analysts’ long-term valuation forecasts. Those derive from an in-house dividend-discount model that is fed by the team’s earnings, cash flow, and growth-rate estimates. The analysts rank stocks in each industry based on their estimated fair value. The managers incorporate these rankings into their stock-picking, expressing modest sector preferences based on their macroeconomic view.
Portfolio:
This benchmark-aware and highly diversified fund held 289 stock positions per end of November 2021, of which 124 are shorts. The long leg of the fund is conservatively managed, with modest bets versus the Russell 1000 Index and an active share of 55%-60%. NXP Semiconductors, Alphabet, and Amazon.com were the largest active positions in the portfolio, with an overweight of around 200 basis points. Rivian was bought in 2021 for risk-management considerations to offset the underweight of Tesla, which the managers never held. Most stocks that are sold short in the 30/30 extension carry a weight of less than 25 basis points.
People:
Growing confidence in the two experienced portfolio managers and the large and seasoned analyst team supporting them leads to an upgrade of the People Pillar rating to Above Average from Average. Susan Bao is an experienced and long-tenured manager on this strategy and is well-versed in the firm’s hallmark investment process. Bao and Luddy have also managed this 130/30 strategy together since the start of the U.S.-domiciled vehicle in 2005 and since 2007 on its offshore counterpart. Steven Lee succeeded Luddy in 2018. Lee brings close to three decades of experience, but most of it was gained as an analyst. Since 2014, he has managed JPMorgan US Research Enhanced Equity, the firm’s analyst-driven long-short strategy, which serves as the blueprint for this strategy’s 30/30 extension. Although portfolio management is collegial, Bao concentrates on consumer, financials, and healthcare, while Lee is the lead for industrial/commodities, technology, and utilities/telecom. While their collaboration is still relatively short, it has already proved fruitful, and the managers have demonstrated their ability to generate alpha from both long and short ideas provided by the analyst team.
Performance:
It has outperformed the Russell 1000 Index on a total return and alpha basis since inception and over shorter time horizons. Since Susan Bao and Steven Lee have comanaged the strategy, a more relevant period to consider, the strategy also outperformed its average peer and the index. However, results were a bit mixed during that period, with a disappointing performance in 2018 offset by successful stock-picking predominantly in 2020 and 2021. The strategy had a good year in 2021, as stock selection in the long-leg and in the market-neutral component contributed positively. Positions in semiconductors, banks, and energy helped.
(Source: Morningstar)
Price:
It’s critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category’s costliest quintile. Such high fees stack the odds heavily against investors. Based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we don’t think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Neutral.
(Source: Morningstar) (Source: Morningstar)
About Funds:
A growing conviction in the duo that manages JPMorgan U.S. Large Cap Core Plus and its Luxembourg resided sibling JPM U.S. Select Equity Plus, and the considerable resources they have effectively utilised, lead to an upgrade of the strategy’s People Pillar rating to Above Average from Average. The strategy looks sensible and is designed to fully exploit the analyst recommendations by taking long positions in top-ranked companies while shorting stocks disliked by the analysts. Classic fundamental bottom-up research should give the fund an informational advantage. The portfolio is quite diversified, holding 250-350 stocks in total with modest deviations from the category index in the long leg. The 30/30 extension is broadly sector-, style-, and beta-neutral. Here the managers are cognizant of the risks of shorting stocks, where they select stocks on company-specific grounds or as part of a secular theme. For example, the team prefers semiconductors, digital advertising, and e-commerce offset by shorts in legacy hardware, media, and network providers. Short exposure generally stands at 20%-30%, with the portfolio’s net exposure to the market kept at 100%. The strategy’s performance since inception, which still has some relevance given Bao’s involvement, has been outstanding.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Through acquisition and internal development, Eastman owns a solid portfolio of specialty chemicals. Eastman’s specialty chemicals include plastics and components used in safety glass, window tinting, and specialty plastics, which offer a solid growth profile. To increase its specialty portfolio, the firm invests roughly 4% of sales from its additives and functional products and advanced materials segments into research and development, which is in line with its specialty chemical peers. Eastman is well positioned to meet growing demand for auto window interlayers, including heads-up displays, and specialty plastics.
Eastman also holds a solid position in acetate tow, which is primarily used to make cigarette filters. The acetate tow industry has experienced falling prices due to overcapacity in China over the past several years. However, a handful of players dominates the industry, a factor that led to disciplined capacity shutdowns by all of the major companies during the industry downturn. To offset some of the decline, Eastman has been investing in capacity for other uses for its fibers, including fabrics and apparel.
Financial Strength:
Eastman is in good financial health. As of Dec. 31, 2021, Eastman carried around $4.7 billion in net debt on its balance sheet. Management reported net debt/adjusted EBITDA was a little less than 2.2 times. With strong free cash flow generation and the sale of its adhesive resins portfolio for $1 billion in cash in 2022, it is assumed that Eastman will have no trouble meeting its financial obligations, including dividends. Assuming no major acquisitions are made, the company will be able to maintain leverage ratios within management’s long-term target of 2.0-2.5 times over a number of years. However, the cyclical nature of the chemicals business could cause coverage ratios to fluctuate from year to year.
Bulls Say:
Eastman is well positioned to meet evolving chemical demands in auto window interlayers and tires through its best-in-class patented products.
Eastman’s investments in plants that use sustainable based feedstocks, including recycled chemicals and wood pulp, should benefit from growing demand for specialty plastics made from these feedstocks.
As Eastman continues to develop new patented products, it should expand its specialty chemicals business, which generates higher margins and commands some degree of pricing power.
Company Profile:
Established in 1920 to produce chemicals for Eastman Kodak, Eastman Chemical has grown into a global specialty chemical with manufacturing sites around the world. The company generates the majority of its sales outside of the United States, with a strong presence in Asian markets. During the past several years, Eastman has sold noncore businesses, choosing to focus on higher-margin specialty product offerings.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Celanese is the world’s largest producer of acetic acid and its chemical derivatives, including vinyl acetate monomer and emulsions. These products are used in the company’s specialized end products and also sold externally. Celanese produces the chemical in its core acetyl chain segment (roughly 70% of 2021 EBITDA), which primarily serves the automotive, cigarette, coatings, building and construction, and medical end markets. It produces acetic acid from carbon monoxide and methanol, a natural gas derivative. Celanese produces its own methanol at its Clear Lake, Texas, plant, which benefits from access to low-cost U.S. natural gas. The company recently announced that it will expand acetic acid production capacity at Clear Lake by roughly 50%, which should benefit segment margins thanks to lower average unit production costs
The engineered materials segment (around 25% of 2021 EBITDA) produces specialty polymers for a wide variety of end markets. The automotive industry accounts for the largest portion at around one third of segment revenue; other key end markets include construction and medical devices. This segment uses acetic acid, methanol, and ethylene to produce specialty polymers. Celanese and other specialty polymer producers have benefited in recent years from automakers light weighting vehicles, or replacing small metal pieces with lighter plastic pieces. Celanese should also benefit from increasing electric vehicle and hybrid adoption, as the company makes battery separator components.
Financial Strength:
Celanese is currently in excellent financial health. As of Dec. 31, 2021, the company had around $4 billion in debt and $0.5 billion in cash. Celanese is undergoing a portfolio transformation, exiting legacy joint venture deals and acquiring new assets to increase its engineered materials portfolio, such as the Santoprene business from ExxonMobil, which resulted in slightly higher debt. However, it is generally expected that the company’s balance sheet and leverage ratios to remain healthy as Celanese should generate enough free cash flow to meet its financial obligations. The cyclical nature of the chemicals business could cause coverage ratios to fluctuate from year to year. However, Celanese should still generate positive free cash flow well in excess of dividends.
Bulls Say:
Celanese built out its core acetic acid production facilities at a significantly lower capital cost per ton than its competitors thanks to the scale of its facilities (1.8 million tons versus average 0.5 million tons).
Celanese should benefit from producing an increasing proportion of its acetic acid in the U.S. to take advantage of low-cost natural gas.
The engineered materials auto business should grow more quickly than global auto production because of greater use of these products in each vehicle.
Company Profile:
Celanese is one of the world’s largest producers of acetic acid and its downstream derivative chemicals, which are used in various end markets, including coatings and adhesives. The company also produces specialty polymers used in the automotive, electronics, medical, and consumer end markets as well as cellulose derivatives used in cigarette filters.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Laverne Securities Pty Ltd, ACN 629 216 477, T/As Investor Desk, is a Corporate Authorised Representative of Laverne Capital Pty Ltd (AFSL 482937). This service is administered by OpenInvest Limited ACN 614 587 183 via the OpenInvest Portfolio Service ARSN 628 156 052. This website provides factual information about the service, and any general advice contained does not take into account your objectives, financial situation or needs. Before making any investment decision, please review the PDS and Target Market Determination available at https://www.investordesk.com.au/key-documents/. Should you require assistance in determining whether an investment in the service is right for you, you may wish to seek personal advice from an appropriately licensed financial adviser.
