There's a big difference between commodity chemical companies and specialty chemical companies - both can make you money, but companies with more of a commodity orientation have to be sold more nimbly. That's not to say, however, that investors can just buy a company like Albemarle (NYSE:ALB) whenever they may like. While this is a very interesting and well-run chemical company, today's valuation doesn't offer much discount despite multiple challenges to the business.
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Three Companies In One
Albemarle is essentially three chemical companies in one, as the company gets broadly-equal contributions to revenue from its polymer solutions, catalyst and fine chemical operations. In polymer solutions, flame retardants (particularly bromine-based products) are the dominant contributor to results, though the company also sells various curatives, antioxidants and stabilizers. The catalyst business is largely focused on catalysts needed in refining oil and various organometallics. Last but not least, fine chemicals is built around various bromine products, as well as products for agriculture, pharmaceuticals and the energy markets.
Strong Share And Visible Competition
At least part of Albemarle's success can be tied to its strong share in many markets. Bromine supply is very nearly a triopoly with Chemtura (NYSE:CHMT) and Israel Chemicals (OTC:ISCHY), and the company likewise has significant share in categories like bromine-based fire retardants and bromine products used in consumer electronics.
Albemarle also owns significant share in the refinery catalyst market, with Royal Dutch Shell (NSYE:RDS.A), W.R. Grace (NYSE:GRA) and BASF (OTC:BASFY) standing as its largest rivals. Although the company holds less share and faces a more diverse group of competitors in the fine chemicals operations, it is nonetheless a leading producer of both ibuprofen and fluids used in energy exploration.
SEE: Economics Basics: Monopolies, Oligopolies And Perfect Competition
Changing Markets Will Give, And Take, Opportunities
On the positive side of the ledger, Albemarle should be able to look forward to more and more heavy oil usage in the refining process, and heavy oil refining typically requires more (and/or more expensive) catalysts. At the same time, tighter air quality standards could increase the demand for Albemarle chemicals in utility scrubbers.
It would also appear that Albemarle has meaningful opportunities in agriculture and technology. The company's organometallics technologies should make it a significant part of the supply chain for future LED, LCD and AMOLED production. On the agriculture side, an active urease inhibitor product (NBPT) has shown promise as a way to reduce the breakdown of nitrogen-bearing fertilizers in the soil, allowing farmers to use less fertilizer without compromising yields.
But it's not as though the company does not have challenges. Bromine seems to have been in something of a "supercycle" for several years and it's worth asking if the company can continue to maintain past margins. What's more, many consumer electronics companies are phasing bromine out of their products - Apple (Nasdaq:AAPL) was arguably the leader in going bromine-free, but Hewlett-Packard (NYSE:HPQ), Dell (Nasdaq:DELL), Lenovo (OTC:LNVGY) and Samsung have all made commitments to significantly reduce bromine content in their products as well. With electronics representing about 15% of Albemarle's end-market demand, that's not a trivial risk.
Closer to today, the company is also seeing some challenges from the macroeconomic environment. Inventory de-stocking in flame retardants and weak consumer electronics demand have both helped to push down expectations for second half profits. Thinking more broadly, while Albemarle may be better-positioned than commodity chemical companies and has indeed generated strong returns for a while, the company still needs a healthy global economy to do well.
SEE: Explaining The World Through Macroeconomic Analysis
The Bottom Line
Unlike so many chemical companies, Albemarle not only generates good cash flow, it does so on a pretty consistent basis. Assuming that the global economy doesn't really slip over the next year, there's a pretty good chance that Albemarle will be in a net-cash position by the end of 2013, giving the company the option to either acquire more businesses or buy back stock.
With a solid platform of value-added products, I clearly like Albemarle. I cannot say the same for the stock, at least not without some reservations. A discounted cash flow and forward EV/EBITDA both point to fair value in the high $50s. What's more, Albemarle has pretty consistently traded at an average trailing EV/EBTIDA of 8.5 times; comparing that to today's multiple suggests a target price in the low $60s. As a result, while Albemarle is certainly the type of company I'd like to own, I'd need to see more of a pullback in the shares before adding it to my own portfolio.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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