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Morningstar | Clariant's 4Q Worse Than It Looks at First Glance; Shares Fairly Valued

No-moat Clariant reported fourth-quarter EBITDA of CHF 253 million, down 2% from 2017 and below consensus but ahead of our estimate by nearly 10%. The underlying numbers paint a weaker picture. EBITDA was buoyed by a surprise positive performance in catalysis, which saw higher-than-expected petrochemical sales and some orders pulled forward that were scheduled for the first quarter of 2019. This business is notoriously lumpy, and indications from the company last quarter would lead one to believe that the fourth quarter was going to be much weaker. Ignoring the catalysis beat would have resulted in EBITDA falling below even our conservative estimate due to soft results in care chemicals and natural resources.

Clariant did not provide specific guidance for 2019 but instead reiterated its 2021 targets of above-market growth, higher profitability, and stronger cash generation. This does not inspire us with much confidence for the near term, given that cyclical headwinds appear to be upon us. Our 2019 estimates call for around a 5% drop in EBITDA, which we remain comfortable with in light of underlying fourth-quarter performance and growing evidence of a macroeconomic slowdown in Europe and China. Consequently, we don’t expect to make a material change to our CHF 19.50 estimate. At current levels, the shares look fairly valued.

We have concerns surrounding macroeconomic conditions in Europe and China, which is no doubt the consensus view at this point. Clariant’s fourth-quarter results did not do anything to allay these fears. The company noted the environment had grown increasingly challenging throughout the year. Furthermore, in the fourth quarter, Clariant called out a slowdown in China, and sales in Europe declined 2% from 2017.

The weakness in care chemicals was a bit surprising, with EBITDA down 13% from 2017. The aviation business and capacity outages were blamed for the poor results. We can accept that the capacity outages are more of a one-time event. We do expect improving performance over the long term in this segment, given its solid pipeline of new products in consumer care. However, the fact that the aviation business continues to have an impact on performance indicates that the industrial, and therefore cyclical, component in this segment still matters.

We are concerned about the lack of improvement in margins in the natural resources segment. Fourth-quarter EBITDA was down 29% from 2017, but the comparable was undoubtedly tough. However, the EBITDA margin was down 30 basis points sequentially, while guidance was for the opposite after hitting a very disappointing 10% in the second quarter of 2018. Unabated price consciousness of the oil market continues to shoulder the blame. While Clariant’s oil business is somewhat lagged versus peers because of its focus on production rather than exploration drilling, we are surprised that the market continues to be so challenging. We maintain our expectation for some modest improvement in margins next year, given cost savings from the integration of the two recently acquired businesses.