Black is the New Black: Orion S.A. $OEC
Base Hit Stocks
Sometimes I find deep value opportunities that have a chance to be multibaggers. I think that over the next two to five years Sibanye Stillwater (SBSW) will see a $20 stock price, Transocean (RIG) will see $25, and if the activists aren’t successful in taking it private, Forward Air (FWRD) will see $75. But maybe sometimes a base hit is nice to take some moderate profits in a shorter time frame. Businesses whose stock prices haven’t crashed into the basement, but don’t have a banquet of problems to be worked through. Just reasonable, boring businesses, trading at a slight discount, and on their way to mean revert in a relatively short period of time. Even in a down market, companies like UTZ potato chips (UTZ), and Hamilton Beach Brands (HBB), contributed their part to my portfolio in the past, even though they weren’t particularly sexy or with a lot of torque.
Orion S.A. (OEC) is the Luxembourg based producer of carbon black. Carbon black is the fancy term for soot, the byproduct of incomplete combustion. This modern soot is an ingredient in tires, paints, ink, polymers, and even high tech batteries which provide a vector for future growth as hybrids will likely dominate in the next twenty years or so. OEC is the market leader in specialty carbon black, and the number three producer of carbon black for tires. After a negative earnings surprise last quarter, the stock price crashed from $24.50 and sits at $17.15 today.
OEC Price:
Management blames the stock price crash on a sudden glut of cheap tires from Southeast Asia, and the American and European consumers trading down. Interestingly, management also claims that this sudden glut of cheap tires is not indicative of Southeast Asia’s typical costs of production of tires, but that they are trying to offload inventory before Western nations implement some sort of impending tire tariff in order to protect their domestic automotive industry. If true, an import tariff on foreign tires would be a medium term tailwind for OEC.
Tires are only one part of their business, and the coatings and polymer demand for carbon black are strong and growing. Furthermore, as I mentioned in the writeup for Forward Air (FWRD), management did mention the research by Freightwaves that shows we may be climbing out of the trough for trucking; domestic freight is a major driver of demand for tires, and therefore carbon black. Also, with the sanctions on Russia and Belarus, one of the top producers of carbon black, Omsk Carbon, should be unable to export into the US and Europe.
Carbon black is a cyclical business, and management says that the last time they were at the peak of their demand cycle was in 2018. Due to growth in the size of the market and pricing, the next time they hit the peak of the cycle, OEC should do $500 million of EBITDA in one year. Management believes the next year where they hit peak cycle is either 2025 or 2026 or perhaps both. The current market capitalization is just a tad over $1 billion, and even with a few headwinds, current trailing twelve month EBITDA is $285 million.
Earnings per share were $1.74 in 2023, $1.75 in 2022, $1.74 in 2021, $2.22 in 2021, and $0.30 during 2020. Covid really did disrupt a lot of businesses, but it is impressive to turn a profit every quarter since 2015. This year management is guiding toward EPS of between $1.75 and $1.95.
Management is actively buying the stock with large purchases from the CEO and CFO at prices ranging from $12.70 to $23.98. The CEO has spent over $3 million buying shares in the last four years, and the new CFO has spent $750,000 buying shares since he was hired in 2022. Also, on the last earnings call, management announced the initiation of a new share buyback program.
The balance sheet isn’t terrible, long term debt stands at $660 million, although there are some pension liabilities and capital leases bringing the total long term liabilities over $900 million. OEC had $47 million of trailing twelve month interest expense to match up against their $285 million trailing twelve month EBITDA.
The free cash flow story looks worse due to heavy capex spending in prior years. Management is guiding toward very low maintenance capex spending for at least the next two years as their focus turns to efficiency gains that can be done without significant cost. Guidance is from $700 million to $800 million free cash flow from 2023 to 2025, not including growth capex, but growth capex for 2024 is projected to be significant. Any sizable free cash flow is likely to come from 2025 or beyond.
If you want to buy OEC for a quick reversion to the mean, management is guiding for improvement in Q3 and Q4 of this year. It is entirely possible that the stock price can climb from $17.15 back toward $25 within six months to a year, about a 45% return. If you are interested in owning a business for the long term that is a market leader in their field, has incentive alignment with management, engages in share buybacks, and has the potential for growth as electric vehicles not only need carbon black for their batteries, but with added weight and torque, need twice as many tires as internal combustion vehicles, OEC isn’t a terrible buy and hold company either.
Soot might not be sexy, but OEC has a very decent short term return possibility with much lower risk than what I am typically attracted to. That gives it the character of a base hit instead of swinging for the fences, and depending on your preferences, that might be a superior risk reward profile.