Cabot Stock: Swell Business (NYSE: CBT)

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Abstract Battery supply digital concept

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American needs to be able to be energy-independent and battery technology is one way of getting there. – Jennifer Granholm

Introduction

If you’re a subscriber of The Lead-Lag Report, you’d note that I’ve been highlighting the somewhat volatile and sideways pattern of the broad materials sector that has been in place for around 8 months now. Buoyed by the recent strength in commodities, it looks like this sector could be poised to break out of this sideways zone. One of the most promising yet underappreciated names in the materials sector is Cabot Corp (CBT). CBT is a specialty chemicals and performance materials company that is primarily noted for its competence in producing high-grade carbon black.

Why CBT?

Whilst CBT’s carbon additives are used in a whole host of industrial and commercial applications you could perhaps best view it as an indirect proxy on recovering auto sales momentum. Carbon additives are used not just on tires but with seatbelts, indoor plastics, etc. as well (management believes that one-fourth of group sales is linked to auto production). The persistent chip shortage for much of H2-2022 disrupted global light vehicle sales and whilst supply chain-related issues have not completely evaporated, things are indeed looking up for FY22 and FY23.

Vehicles

Fitch Ratings

It’s worth noting that one of the benefits of Cabot is that it has manufacturing and distribution units across the world so this localization comes in handy when you want to reduce delivery times. Customers prefer to have associations with entities such as CBT that can shorten the supply chain and this was rather evident last year. CBT management confirmed that their performance during the difficult supply chain environment helped increase their profile in the market and thus they were able to sign a range of customer agreements with increased pricing clauses. The benefits of this are poised to be reflected in CBT’s EBIT from the next quarter onwards.

In fact interestingly, do also note that in the recent earnings release, we also saw CBT upgrade its FY22 EPS estimates for the year. Previously they were guiding to an adjusted EPS range of $ 5.2- $ 5.6 for FY22; now, you’re looking at a range that is roughly ~ 6% higher at $ 5.7- $ 5.9. Long term, CBT is expected to deliver fairly impressive adjusted EPS growth of 8-12% until FY24.

I’d also like to commend CBT for its fairly well-balanced capital allocation priorities. Firstly, they look to pursue bolt-on M&A deals without overleveraging the balance sheet. In fact, currently, the net debt to EBITDA only stands at 1.8x, below the company’s long-term target of 2-2.5x. Then there’s also the firm’s cash-generating ability (going forward CBT expects to generate roughly $ 1bn of discretionary cash flow over the next three years). A combination of these two aspects means, the company is also in a good position to reward shareholders both via buybacks and dividends. In the recently concluded quarter, the company paid $ 21m of dividends and repurchased $ 19m of shares.

EV battery materials potential is just kicking off

Besides some of CBT’s core traditional strengths, I’d also like to highlight the very promising opportunity in the EV battery materials space. There’s no denying that EV penetration continues to ramp up at an unbelievable pace and Federal agencies across the world are setting ambitious targets. In fact as noted in The Lead-Lag Report, the ruling administration here believes that by 2030 they can get to a universe where 50% of vehicle sales will be electric based.

Vehicles

Twitter

The US is just one of many nations fast embracing the EV culture and this has a cascading effect on the materials that are used to build EV batteries such as lithium.

Lithium

Twitter

CBT is attempting to make its mark here by offering a range of conductive carbon additive products that can help speed up the transmission of electrons in a battery and help with faster charge and extended range. CBT is particularly well-positioned as it has a global footprint of manufacturing assets and can benefit from tailwinds across the world rather than just one region. You’d be interested to note that they have tie-ups with 6 out of the top 8 battery producers of the world (the top 8 battery producers control 90% of the market). CBT also recently qualified for a new EV battery program with one of the top 5 battery manufacturers that is expected to go live in Q3-22.

Production

CPT Presentation

CBT believes the carbon additive market will cross the $ 3bn mark by 2027 and will likely grow at 30% till 2030. All in all, it’s worth noting that CBT’s battery materials business is expected to see fairly strong progress at the operating level. FY EBITDA is poised to ramp up from $ 16m to anything between $ 25- $ 35m next year (at the mid-point of this guidance you’re basically staring at 87.5% annual growth).

Q3

CBT Presentation

Conclusion

Broadly there’s a lot to admire about CBT but there are also certain risks / drawbacks that prospective investors should be aware of. One is the impact of high crude oil prices. This tends to put a lot of pressure on the company’s working capital position by way of higher inventories and higher receivables. With crude at $ 100, you’re looking at some fairly significant pressure on the FCF generation. Then also note that the stock is also close to lifetime highs with current forward P / E valuations 22% higher than the long-term average. Fantastic business but is there value on offer at these levels? Probably not.

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