Buy Braskem: Strong International Demand is Pushing Production Towards Full Capacity

Summary

In Q2 2016, BAK’s revenue came out at $3.39 billion and net earnings came out at US$121.08 million

BAK’s gross profit margin increased to 27.38%, which is a significant improvement compared to Q4 2015

Strong demand in international market and healthy spreads would likely help BAK maintain and increase profitability in coming quarters

BAK has an average price target of $16 per share, which offers secondary investors an 18.43% upside potential

Company Overview

Based in Brazil, Braskem SA (NYSE:BAK) was founded in 2002 as a chemical company primarily involved in producing thermoplastic resins. Besides various petrochemical products, Braskem SA also produces Polyolefins and Vinyls.

Although Braskem SA’s focus is in the Latin American market, they also operate a chemical distribution network and exports to the international markets, such as in the United States and greater Europe.

Besides running around 40 industrial units, where majority of them are located in Brazil, Braskem SA also invest in other companies as shareholders.

As of August 17, 2016, Braskem SA had a market capitalization of $4.91 billion and employed 8,126 people to run its global operations.

Review of Q2 2016 Financial Results

01_revenue

Figure 1: Braskem SA’s Q2 2016 Revenue Came Out at $3.39 Billion

On August 4, 2016, Braskem SA ((BAK-US)) released its Q2 2016 earnings, which showed that the company has generated US$ 3,3900 million ((R$11,886.17 million)) in revenue and US$ 121.08 in net earnings.

02_USDBRL

Figure 2: USD/BRL Price Chart

Compared to Q2 2015’s R$ 11,591.77 million, this year’s Q2 revenue increased by 2.54%, but the continuous appreciation of BRL against the USD, which fell from around USD/BRL 4.15 to USD/BRL 3.2, over the last six months has helped increase their revenue in USD. That’s why we see a sharp uptick in figure 1. However, we believe the appreciating BRL would make it harder for the company to compete in the international market in the coming quarters.

03_gross_profit_margin

Figure 3: Gross Margin Widened to 27.38%

In addition, Braskem SA’s gross profit margin experienced significant improvement compared to Q4 2015 and came out at 27.38%, demonstrating that the management has improved efficiency.

04_price

Figure 4: Braskem SA’s Stock Price Has Gone Up 19.35% Since Releasing Q2 Results

Since Braskem SA released its Q2 earnings, their stock price has climbed from $11.30 to $13.80, and currently trading at $13.51, representing a 19.35% increase.

Takeaway from Q2 Earnings Call

During the Q2 earnings call, Pedro Teixeira, the IR Controller and Project Finance Director of Braskem SA, mentioned that the resin market expanded by 3% compared to Q1 and now it is around 1.2 million tons. He also mentioned that resin exports also grew during Q2 by 21% compared to the same quarter last year.

Mr. Teixeira sounded optimistic when he said that the crackers in Brazil “operated at a capacity utilization rate of 94%, 1 percentage point higher than in the same period last year, and 5 percentage points higher than in the first quarter 2016.” He attributed the improved capacity utilization rate to “production from the gas-based cracker in Rio de Janeiro, given the higher supply of feedstock in the period.”

In Q2, 75% of the company’s consolidated EBITDA came from exports. As we mentioned earlier, since the strong demand in the US was the primary driver behind the increase in export, we believe the strong Brazilian Real may make Braskem SA uncompetitive in the coming quarters.

Furthermore, the cracker capacity utilization rate is approaching its full output potential. Hence, it is highly possible that Braskem SA will soon become unable to meet the export demands, unless they make some large capital investment to boost their production capacity soon.

But, we are optimistic that the Mexican plant, which was gradually commissioned throughout the first half of the year and has a 32% utilization rate, will help Braskem SA to meet international demands.

Hence, we remain optimistic that we will keep hearing statements like “U.S. dollars, EBITDA in the first half increased by 21% year-over-year to US$1,638 million,” in the near future as well.

As a polypropylene producer, the polypropylene to propylene spreads are vital to the overall margin of Braskem SA. We were curious to know how the Braskem SA management expects this spread in the coming months, as it would highly influence how their increasing gross profit margin will play out.

The CEO, Fernando Musa, reassured that “despite some potential volatility in the near-term, PP propylene spreads should remain healthy.” He justified his stance by saying “the new PP capacity are not expected to come online before 2018. Therefore, spreads will remain at high levels until that year.”

Conclusion

With a sharp increase in gross margins prospects of strong international demand, the main question now is that can Braskem SA meet the demands and deliver? It seems the management is focusing a strategy that will try to meet local demands first and then focus on the export market.

However, we can understand that why they are downplaying the importance of exports from Brazil, especially now. Because the BRL is appreciating fast and it makes investors nervous.

Regardless, we don’t really think the currency issue will affect their revenue more than the demand side of this equation, namely managing to keep production in sync with demand.

According to Yahoo! Finance, the average price target of Braskem SA is $16 per share. Based on the current market price of $13.51, it offers secondary investors a 18.43% upside potential.