Johnson Matthey (JMAT LN): catalysing growth
Johnson Matthey (JMAT LN), P GPB 24.1, Market cap. GBP 4.7b, Target P 31.3 (30% upside)
Business: leading manufacturer of automotive catalysts, industrial catalysts, recycles precious metals and produces fine chemicals. Demand for catalysts remains robust over the medium term, driven by tigher emission contrl legislation. However, operating profit in the y/e 13 March 2016 is forecasted to decline (Blb Consensus -15%) due to temporary headwinds (weaker demand in Oil & Gas applications, diesel emissions VW debacle, disposals).
Currently stock trades on trough earnings valuations (P/Eest x13.6, EV/EBITDA x6.7), a 40% discount to the European Chemicals sector (EV/EBITDA x9.1) and a 32% discount to the closest peer, Umicore (UMI). JMAT used to command premium valuation over UMI reflecting the higher ROIC (17% v 8.6%).
Emission Control Technologies (ECT): Manufactures catalytic systems for vehicle emission control, heavy duty diesel. (61% of group sales, 54% of group EBIT)
Diesel catalysts: US risk exacerbated, only 0.5% of the US new cars run on diesel, post VW debacle the US is becoming a single model market mostly represented by the mid-sized pick up truck ‘Dodge Ram’ (Liberum 4/12/15). EU demand remains robust, diesel represented 57% of new car sales.
Tightening regulation will require more sophisticated catalyst systems, adding roughly 20% to the revenue per unit (guidance by JMAT, UMI, BASF). Since Sep. 2015 that EURO-6 regulation became effective automakers are required to reduce CO2 emissions from 130 gm/km in 2014 to 95 gm/km by 2020. Testing standards will be further raised in 2017/18 with Real Driving Emissions tests simulating real-driving conditions. This tight regulatory environment creates a strong growth catalyst for ECT. ASP for passenger vehicles costs USD 320 – 510 per unit, for light duty trucks USD 420 -500 per unit.
Process Technologies: Manufactures catalysts used in industrial processes, applied in petrochemical industry, gas processing, refineries. (18% of group sales, 18% of EBIT). Although some of the activities were affected by softness in Oil & Gas industry (44% of revenue), demand in Diagnostics applications remains robust and management guides towards growth in next year, alongside a recently announced cost-cutting programme expected to trim fixed costs by 20% of divisional EBIT in 2016/17.
Precious Metal Products (PMP): Specialises in platinum group metals refining / recycling and marketing / distribution. Sources metals from spent catalysts. (9% of group sales, 12% of group EBIT)
Fine Chemicals: develops bio-catalytic technologies and active ingredients for pharma customers (9% of group sales, 16% of EBIT): manufactures active ingredients for the pharma industry.
New Technologies: Battery materials, energy storage (3% of group sales, aiming to grow revenue from current GBP 72m to GBP 300m by 2019/20) Lithium demand: Lithium is used in the cathodes of most batteries, used in transportation and renewables. Demand is forecasted to grow at a CAGR of 16% over next decade (Albemarle, ALM US).
Debt: JMAT disposed of the gold and silver refining business together with the chemicals research division for GBP 380m. Most of the proceeds (GBP 305m) were paid as a special divi (GBP 150p per share, ex-date 11/1/16). Even post special-divi, balance sheet appears under-levered with Net Debt/EBITDA estimated at x1 and Debt/Equity at x0.6.
Valuation: Consensus forecasts FY16 EBIT -13%yoy at GBP 460m and Bloomberg suggests analysts’ degrading cycle started reversing with consensus projecting mid-single-digit EPS growth for next 3yrs.
Current stock price implies a potential 30% upside for JMAT to trade at the historical average EV/EBITDA x8.7 and 40% upside if JMAT trades at similar multiple to European Chems. (SX4P)
Divi 2.9% (ex-special), EV/EBIT x11.3, P/BV x2.4
Next Catalyst: 3/2/16 Trading update (tomorrow), 2/6/16 12M results for y/e 31/3/16
EPS consensus downgrade cycle appears to reverse