Quick Pitch: OCI N.V. (OCI:AS)

Large Asset Sale/Potential Capital Return – Upside TBD

It’s another one of those ‘large asset sale + potential capital return’ setups that we are very fond of at SSI. I first came across the situation in Palm Harbour Capital’s Q4’23 investor letter.

OCI is a $6bn market cap ($8.3bn EV) Amsterdam-listed nitrogen fertilizer and methanol producer. After facing pressure from activist investor Inclusive Capital to explore asset sales in early 2023, the company initiated a strategic review. The review process concluded in December when OCI signed agreements to sell two of its major assets, US nitrogen fertilizer production business and a 50% stake in publicly-listed fertilizer producer Fertiglobe, for net proceeds of $6.1bn. The remaining company will encompass OCI’s European nitrogen fertilizer business, development-stage Texas Blue ammonia plant and the global methanol production segment. OCI shares have jumped significantly since the asset sale announcements, however, pro-forma for the proceeds, the RemainCo still looks cheap trading at only c. 3.5x mid-cycle EBITDA compared to 5x+ multiples for publicly-listed peers. I would expect OCI shares to re-rate once the asset sales close. Another potential catalyst here is a substantial capital return as OCI’s management expects to return a significant portion of the proceeds to equity holders.

Below is a quick thesis summary from Palm Harbour:

Another of our long-term holdings, which has morphed into a special situation is OCI, the Dutch nitrogen fertilizer and methanol producer, introduced in our second quarter 2019 letter and further updated in our fourth quarter 2021 letter., We had lowered exposure substantially over the course of 2022 and the first quarter of 2023 after a bumper 2022, in which we received €8.9 per share in dividends in the course of 18 months. We once again began increasing our stake as Jeff Uben of Inclusive Capital (formerly of ValueAct) wrote to the board demanding they unlock value. Chairman and majority owner Nassef Sawiris, ever the dealmaker, obliged and instigated a portfolio review. The outcome of which was revealed in December, with the complete sale of their 50% stake of Abu Dhabi listed Fertiglobe to ADNOC for $3.6 billion plus earn-outs followed rapidly by the sale of Iowa Fertilizer Company to Koch Industries for $3.6 billion. While the market re-rated the shares from horribly depressed levels, it is still more or less valuing the company close to the value of the two deals, leaving the Texas blue ammonia plant, the methanol business as well as the entire European nitrogen business for free.

Both asset sales are expected to close in 2024 subject to regulatory/antitrust approvals. These approvals appear highly likely to be received. The risk of the acquirers walking away is also minimal. Koch Industries is one of the largest industrial conglomerates in the US whereas Abu Dhabi National Oil Company (ADNOC) is among the world’s largest oil production companies.

Below is my attempt to elaborate on three key questions crucial to the investment thesis:

  • What does management plan to do with the sale proceeds?
  • What mid-cycle earnings will the RemainCo generate?
  • What multiple should the RemainCo trade at after the transactions are completed?

Keep in mind that OCI is a large-cap company so the market might be pricing this situation correctly.

 

Capital allocation

Pro-forma for the asset sale proceeds, the company will boast a gross cash position of $7.8bn versus approx. $3bn pro-forma debt. Management said that some of the proceeds will go to cover the debt and some to fund further growth capex. However, management has stated that a significant portion of the proceeds are expected to be returned to equity holders, while hinting that further asset divestitures might be in the cards (see quotes from the recent conference call below):

As you can imagine, in the context of these transactions, this is a transformational moment for the company, that puts us in an extremely solid footing going forward from a — being well capitalized and allows us to retain a meaningful amount of cash potentially on the balance sheet to tackle these smart growth opportunities going forward that Ahmed described, and we will be able to return a substantial amount of capital to shareholders, not only that, but also in a very tax-efficient manner.

This is the conclusion of our strategic review, but I do want to, obviously, remind you …our approach is to continue to focus on value creation for stakeholders and shareholders. So to the extent that there is an opportunity to find a better home for an asset where we could achieve a good valuation, and that’s something that I wouldn’t rule out over the course of the next several years.

Growth capex into Texas Blue ammonia plant as well as other initiatives for 2024 is expected to be around $600m (on top of $275m in maintenance capex). Thus, even accounting for debt reduction and growth proceeds, there should clearly be a ton of cash left for potential capital return.

And we now share our guidance for 2024 at circa $600 million, driven by the build out of our Texas Blue Clean Ammonia facility as we approach operation in early 2025. The guidance also includes other attractive growth CapEx initiatives, including the U.S. nitrogen landfill in Texas, the completion of the New Star pipeline connection, the Rotterdam terminal expansion work and continued progress on Sorfert, Fertiglobe’s low carbon project in Abu Dhabi.

The risk of management wasting these asset sale proceeds seems minimal given the executive chairman’s substantial ownership (39%) and the recent shareholder friendly actions, including 3 special dividends paid out over the last two years (€1.45/share in Jun’22, €3.55/share in Oct’22, and €3.50/share in Apr’23).

 

Normalized profitability of the RemainCo

OCI’s remaining segments encompass its European nitrogen business, the development-stage Texas Blue ammonia plant and the global methanol business. OCI’s management expects the remaining business to generate $600m to $700m in mid-cycle EBITDA. My understanding of nitrogen fertilizer and methanol businesses is very limited, however, a glance at historical profitability suggests that this estimate might be reasonable. Management has also noted that the remaining segments generated $500m EBITDA in 2021, which they referred to as a good reference point for “below mid-cycle” level of earnings. It also excluded any contribution from the development-stage ammonia plant expected to be launched early 2025. From the latest M&A call:

Well, one way of looking at it, which is helpful is that if you look at a year like 2021, for example, which was not the 2022 stellar prices that we experienced or maybe previous years, where we were still going through some troubleshooting of assets. That year alone has adjusted for the various EUAs that we have as part of the results was — and assuming a proportionate adjustment of holdco costs for the resizing of the business. That year, our RemainCo would be just under $500 million of EBITDA. And that was not a — that year was, I would say, below mid-cycle in terms of pricing, and excluded — and excludes the future EBITDA and cash flow streams of Texas group that is yet to come online in 2025.

Combined, these two remaining businesses nitrogen and global methanol businesses generated c. $240m-$730m in segment-level EBITDA during 2018-2022 (see table below). Corporate overheads were around $100m, but should be much lower following the divestments. Recent profitability has sharply declined due to an ongoing industry downcycle in both segments. The European nitrogen business recorded -$158m in TTM EBITDA while the methanol segment generated $130m. However, OCI has highlighted that nitrogen and methanol prices hit a low point in Q3’23 and have since rebounded by over 30%. Meanwhile, prices of natural gas (a key production input) have markedly decreased from their 2022 highs. Therefore, the businesses seem to be inflecting.

Historical segment-level EBITDA:

OCI EBITDA

 

RemainCo valuation

Management’s mid-cycle EBITDA guidance would imply a 3.5x EV/EBITDA multiple for OCI. Below are several reference points suggesting that this valuation is rather low.

Methanol business:

  • US-listed methanol producer Methanex is currently trading at 7.8x TTM EBITDA and 5.2x 2021 EBITDA.
  • Back in late 2021, OCI agreed to sell a 15% stake in its global methanol business at an implied valuation of $2.5bn or 4.8x 2021 EBITDA.

European nitrogen business:

  • Norway-listed nitrogen fertilizer producer Yara International (focuses on Europe and the Americas) is trading at 5.4x TTM EBITDA. On 2021 EBITDA (i.e. at below mid-cycle pricing), the company is valued at a 4.2x multiple.
  • The two divested nitrogen assets, IFCO and a 50% stake in Fertiglobe, were sold at 8.2x and 6.1x TTM EBITDA multiples respectively. Worth noting that IFCO might deserve a premium over OCI’s European nitrogen business given its access to low-cost US gas.

Re-rating to 5x mid-cycle EBITDA would result in around 20% upside from current prices.

2 Comments

2 thoughts on “Quick Pitch: OCI N.V. (OCI:AS)”

  1. OCI reported Q4’23 results. While business performance was pressured due to the ongoing industry downcycle in both methane and nitrogen segments, some improvement has been observed on a sequential basis (EBITDA up by 28% versus Q3’23), driven by nitrogen and methanol prices rebounding from their lowest points in Q3’23.

    Most importantly, management reiterated intentions to pay out a substantial portion of the pending asset sale proceeds to equity holders. After debt reduction and funding of the remaining capex related to the Texas Blue ammonia asset, the company expects to return “at least $3 billion” or approximately 50% of the current market cap to equity holders during 2024. Management once again hinted that further divestitures might be in the cards, stating that it is exploring “further value-creative strategic actions” after receiving “inbound interest in the continuing business.” OCI stock has barely budged since the announcement, and, pro-forma for the divestiture proceeds, the company remains cheap, trading at only 2.8x management estimated mid-cycle EBITDA of the remainco.

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