Introduction

As it has been more than eight months since I had another look at Celanese (CE) which enjoyed a nice share price boost after my original article in November last year, I figured it was time to follow up again to see if I needed to fine-tune my expectations. Back in March, I wasn’t too impressed with the valuation (especially as it looked like we were in for a rocky 2019 for the world economy which would put Celanese’s financial performance under pressure), but it’s always worth to review the company’s performance every once in a while.

Data by YCharts

A glance at the first nine months of the financial year

After a relatively weak second quarter, Celanese gathered some momentum again in the third quarter as although its revenue decreased by approximately half a percent compared to the second quarter of the year. Its operating income increased by around 40% QoQ. That’s perhaps not something to get extremely excited about as the weak Q2 performance on the operating profit level was predominantly caused by a non-recurring $98M expense, but it’s good to see Celanese’s performance getting back to normal levels. The entire reported performance in Q3 is a bit of a mixed bag: Much better than the reported results in Q2, but not nearly as good as the Q3 performance last year as especially the acetyl division reported a $107M lower operating profit.

Source: press release

In the third quarter, revenue came in at $1.59B, a small decrease, while the COGS showed a 0.3% increase. Nothing too alarming, but this did mean the gross profit fell by approximately 2%. Fortunately, the lack of the non-recurring charge had a positive impact on the operating profit which increased from $186M to $260M. An excellent result but still roughly 30% lower than the $374M in operating profit it generated in the third quarter of last year.

Source: SEC filings

Additionally, the attributable income from investees also decreased, and the pre-tax income fell by a similar 30% compared to Q3 last year, but actually increased by a similar percentage compared to the second quarter of this year. With a net income of $263M or $2.18/share, Celanese’s EPS increased again compared to the $1.68/share in Q2 but is nowhere near the $3.02/share it reported in the third quarter of last year. The EPS in the first nine months of this year came in at $6.46, which means Celanese was able to keep the damage limited compared to the $8.19 EPS in 9M 2018, but keep in mind the average share count decreased by almost 8% which had a noticeable impact on the per-share result. If we would divide the 9M 2019 net income by the average weighted share count of 9M 2018, the EPS would have dropped below $6.

Fortunately, Celanese’s incoming cash flows remained strong. It reported an operating cash flow of $1.13B, but, on an adjusted basis, this fell slightly to $1.11B. Still a respectable result but not as good as the approximately $1.37B in adjusted operating cash flow generated in the first nine months of last year.

Source: SEC filings

Despite this, Celanese should be satisfied with its performance. As the capex was just $226M, the adjusted free cash flow generated in the first nine months of the year came in at approximately $890M. A decent result, but this did mean the company had been overspending on shareholder rewards.

How does Celanese spend its cash? A look at its capital allocation preferences

During the first nine months of the year, Celanese spent a total of $990M on keeping its shareholders happy in a combination of dividends ($225M) and buying back stock ($763M).

The $763M allowed Celanese to repurchase 7.33 million shares, and after taking the 570,000 new shares (through stock awards and option exercises) into account, the net share count in the first nine months of the year decreased by almost 6.8 million shares. The stock was repurchased at an average price of $105.67/share which is an excellent price compared to the current share price.

Celanese originally was only buying back stock when it thought it was opportune to do so, but during the Q3 conference call, the management confirmed it has now been buying back stock at a steady pace since September, and it expects to spend $1B on share repurchases this year. This indicates we will probably see the share count decrease to roughly 119.2-119.5M shares by the end of this year.

Chart

Data by YCharts

The dividend was hiked to a quarterly payment of $0.62 (a 15% increase compared to the previous level of $0.54 per quarter), but this is where it gets interesting. Despite the double-digit percentage dividend increase, the dividend is currently costing the company just a little bit more than before. Paying $2.48 annually over the current amount of 120.9M shares outstanding will cost Celanese almost exactly $300M, which also means the 2% dividend yield is totally safe as it represents a payout ratio of just 25-28%.

However, the higher share count last year (135.8M shares at the start of FY 2018) means that despite the lower dividend payment of $2.16 per share per year, Celanese would still be paying $294M in cash dividends. So despite the nice dividend hike, Celanese will only spend marginally more cash on effectively paying the dividend.

Investment thesis

I have to admit I wasn’t too impressed the last time I checked up on the company in March, but based on the free cash flow performance in the first nine months of the year, Celanese still appears to be reasonably priced. The combination of a stock buyback and dividend increases is a good one, and although one could make the argument that share repurchases are inflating the per share performance, it remains a good strategy to reward its shareholders if there are no opportunities for external growth through acquisitions or repaying debt (most debt consists of bonds that can’t easily be repurchased).

However, I would like to see Celanese spending more cash on repaying its $400M and $500M bonds that mature in 2021 and 2022 as I feel it would make more sense to cut the interest expenses instead of buying back more stock during those years. If both bonds would be repaid without being refinanced, Celanese would cut its interest expenses by almost $47M per year, so that’s definitely something to consider.

Source: SEC filings

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-11-30