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The Long-Term Trend That Makes Braskem an Awesome Buy

By Maxx Chatsko - Feb 7, 2018 at 5:18AM

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American crude oil and natural gas are great news for this Brazilian chemical manufacturer.

The United States' recent shale revolution has completely transformed the global energy landscape -- and virtually overnight. At first, domestic production expansion kept a lid on international crude oil prices, much to the chagrin of OPEC, by removing the world's former largest energy customer from the market. An inevitable reality is now just a few short years away: North American energy independence. It probably could be coaxed into existence today if, say, the right crisis emerged.

That's just the beginning. The impact of booming shale production soon will be felt even more profoundly in international markets. American energy exports could soon top up to 5 million barrels of oil per day (bbl/d) and close to 10 billion cubic feet per day (Bcf/d) of natural gas. Put more poetically, we ain't seen nothing yet.

Given that these changes are being spawned from American energy assets, investors would be forgiven for focusing their sights solely on American energy stocks. But the long-term trend of booming North American energy production is also a once-in-a-lifetime growth opportunity for Brazilian chemical manufacturer Braskem (BAK 2.26%). A little digging reveals why that makes sense -- and why the stock is an awesome buy.

A petrochemical facility in the background with a laptop in the forefront.

Image source: Getty Images.

Diversification with American shale

Maybe you've never heard of Braskem, but the nearly $13 billion company is quietly one of the largest petrochemical manufacturers on the planet. It's the seventh-largest and third-largest global producer of polyethylene and polypropylene, respectively. It pioneered a process that converts ethanol into polyethylene, which catapulted it into the pole position among the world's renewable chemical manufacturers. It owns 41 industrial facilities in Brazil, the United States, Mexico, and Germany. 

Much like American shale, the Braskem that exists today sprang into existence virtually overnight. In 2009 the chemical manufacturer derived 73% of its revenue from sales in Brazil and the balance from exports from its home country. That was it. The company had no international presence. Its production facilities were consistent in their inconsistency. Margins were volatile and debt was high.

Well, things have changed. Through the first nine months of 2017, revenue dependence on Brazil and exports from Brazil fell to 53% and 20%, respectively. Sales in the United States and Europe accounted for 20% of total revenue, while Mexico accounted for 7% in the same period. Braskem's production fleet is consistently setting industry standards for utilization rates, process expertise, and safety. Margins are safely positive, and progress is being made to manage its unwieldy debt load. 

Swift diversification was made possible after the company acquired and built new manufacturing capacity in both North America and Europe, including a massive polyethylene manufacturing facility in Mexico that single-handedly altered the country's trade flows. The complex is important not only for its size and massive potential to contribute to Braskem's financial performance for decades to come, but also due to its feedstock: ethane.

A series of pipes in a petrochemical manufacturing facility.

Image source: Getty Images.

Historically, the Brazilian chemical manufacturer relied nearly exclusively on naphtha (a byproduct of crude oil refining) for manufacturing chemicals. And since much of that was purchased from Petrobras, one of its parent companies, Braskem found itself swept up in the political bribery scandal in Brazil. It wasn't exactly an innocent bystander, but much of the uncertainty has since passed, and the event will be firmly in the past once the outstanding balance on its fine is paid in full.

Financial shenanigans aside, diversifying the manufacturing fleet's feedstock options is also important for economic reasons. Why? Naphtha is an industry-standard feedstock and isn't prohibitively expensive, but it's being displaced by ultra-cheap byproducts being created in enormous volumes from American shale fields. When drillers go looking for natural gas and crude oil, they also pull up copious amounts of ethane and propane. But since the United States doesn't (yet) have the infrastructure to upgrade the value of these raw gases, their prices have been essentially pegged at zero.

That new reality has created incredible economic advantages (called "spreads" in the petrochemical industry) for ethane compared to naphtha. As a result, the industry has rushed to construct new world-class cracker facilities to convert ethane into polyethylene and propane into polypropylene. Braskem isn't sleeping on the opportunity.

As stated above, the Brazilian chemical manufacturer is using cheap American ethane at its production complex in Mexico. It's constructing the largest polypropylene facility in the Americas in Texas, which also will be the first built in North America since 2005. And in what may be the most striking example of the economic advantages of American ethane, Braskem is even shipping the feedstock from the Gulf Coast to its manufacturing base in Brazil, where facilities are being upgraded to run on ethane in addition to naphtha.

Toy construction workers building successively taller columns of coins.

Image source: Getty Images.

All of these investments are enabling two things: top-line growth and greatly improved margins. Braskem has increased EBITDA from just $1.6 billion in 2009 to over $3.6 billion in the 12 months preceding the end of the third quarter of last year. Revenue has exploded. Free cash flow generation in the first nine months of 2017 increased 23% compared to the year-ago period. Plus, due to its parent structure, the company is mandated to distribute 25% of net income as shareholder dividends, so investors get to directly benefit from rising EPS. 

Geographic and feedstock diversification also helps to insulate the company and its shareholders from risks in the Brazilian market, which really hurt it during the country's recent recession. In the good times, it will help to have a 70% market share in the fast-growing Brazilian middle class. But when things go sour, the chemical manufacturer can ramp up exports (perhaps by leaning on customer relationships cultivated by expansion into new international markets) or rely more heavily on its international production capacity.

While ramping production in Mexico and the Gulf Coast of the United States will be the primary focus in the next few years, management has hinted at longer-term strategies for diversifying and growing revenue. Braskem has quietly become a leading investor and developer in synthetic biology, in which genetically engineered microbes churn out renewable chemicals.

One of the company's first projects in the space is already showing intriguing potential. Braskem and Genomatica, a no-hype industrial biotech leader, have created a microbe capable of producing the chemical intermediate 2,3-BDO in a single step, compared to a multistep process for petrochemical production methods. That could provide economic advantages while simultaneously enabling a renewable production route for a chemical worth billions of dollars per year.

Cashing in on the opportunity presented by industrial biotech remains a long way off, but serious research and development efforts show Braskem isn't resting on its laurels.

Investor takeaway

Despite being heavily focused in Brazil, Braskem is quickly taking advantage of the American shale energy boom. It's gobbling up cheap ethane for its production complex in Mexico, going all-in with a massive polypropylene facility on the Gulf Coast, and even exporting cheap feedstocks to its home base in South America. Growth is essentially baked in for years to come, while futuristic R&D could capture opportunities in an exciting new field. Simply put, this stock shouldn't be overlooked.

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Stocks Mentioned

Braskem S.A. Stock Quote
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$14.48 (2.26%) $0.32
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