A couple of weeks ago, I wrote on Celanese (CE) for RealMoney, saying it could rise 40% simply by earning the average P/E in its industry.
Today Celanese increased its full year outlook for adjusted earnings per share to between $3.60 and $3.85 from its previous guidance range of between $3.40 and $3.70.
As I noted when I first wrote up Celanese a couple of weeks ago, consensus had already risen to $3.74. Although the stock is up 7% since that recommendation, an industry-average P/E multiple on that number would equal a $60 price for the stock, 33% above the current level.
Since I was away at the time the original article was published and thus failed to link to it, I am reprinting it below.
I’ve been taking a look at chemical maker Celanese, and I have to say I like what I see. I think the shares could rise 44% over the next year simply by expanding its P/E ratio to the average for its industry.
Originally based in Germany, Celanese was incorporated in Delaware in 2005. However, it continues to generate a significant portion of its sales outside North America. In 2007 the company earned 29% of its $6.5 billion in revenue in North America, 43% to customers in Europe and Africa, and the remaining 28% in Asia and the rest of the world.
Celanese is an industry leader in acetyl products and high performance polymers used in a wide variety of industries. The company competes primarily with BASF, Dupont (DD - Annual Report), Eastman Chemical (EMN), Dow Chemical (DOW), Rohm & Haas (ROH), and Air Products (APD). Celanese claims to be the low-cost producer in the industry, an assertion backed by its industry-leading profit margin and return on equity.
Sales rose 12% in 2007 due to favorable currency effects and rising prices. The latter trend has, if anything, accelerated so far in 2008.
Year/Year Percentage Change in PPI for Chemicals
Source: Bureau of Labor Statistics
Celanese has also shown itself to be shrewd when it comes to financial matters. Last year it took advantage of the then-favorable credit market to refinance $2.5 billion of debt, reducing its effective interest rates from approximately 10% to 175 basis points over LIBOR. It also borrowed to repurchase 1.5% of its shares, paying what now appears to be a bargain price of $30.50 per share in a Dutch auction.
The company recently authorized, and began to implement, a $400 million share repurchase. Based on their track record, the repurchase may indicate shares remain a bargain.
As an early cycle recovery play, there is of course some risk that a call on Celanese is… well… early. But I see no point in waiting around for a company that has beaten earnings estimates handily quarter after quarter. In the December 2007 quarter, the $0.93 per share earned compared to estimates of just $0.81. Since then, estimates for 2008 have risen from $3.66 to $3.74, and estimates for 2009 have expanded from $3.61 to $3.91.
The ongoing earnings surprises, surprisingly, have not resulted in an excessive valuation. At 11 times current year earnings, the price compares favorably to the industry average of 15.7 times, as reported by Hemscott. Its free cash flow yield of 4.3% is not eye-popping, but compares favorably to the current yield on five-year Treasuries.
I also think the earnings at Celanese are of higher quality than those of its peers. In fact, its 0% accrual ratio indicates that there is essentially no distortion being caused by accounting accruals, compared to reporting earnings on a cash basis.
If Celanese were to trade at the average P/E multiple for its industry, its shares could rise to $60 over the next year. That would mark a gain of nearly 44% from current levels.
I think there is limited downside due to its already low valuation. There is also potential technical support at the 50-day and 200-day moving averages, both within 10% of the current share price.
Disclosure: At time of publication, William Trent has no position in the companies mentioned in this article.
