Cabot Corporation Stock: Continued Upside Exists, I Say Buy (NYSE:CBT)
Cabot (NYSE:CBT) has once again outperformed slightly the market. It’s not a massive sort of outperformance, but is still, as I see it, worth highlighting in this initiatory 2023 article.
Now, this doesn’t necessarily mean that Cabot is the best sort of investment that you can make today. There are many potential investments on the market today, but it’s nonetheless a decent and justifiable play.
That’s what I’m going to talk about here.
Cabot Corporation – An Update For 2023
Cabot is interesting and remains the company I looked at a few years ago. For the latest quarterly report, we have the 4Q22/full-year results. These results were very positive in several aspects.
As I forecasted, the company’s top-and-bottom-line results delivered record-level results in FY22. The company had record adjusted EPS of $6.28, which is up 25% YoY – despite cost inflation, input costs, wage inflation, and other supply-chain-related issues.
The company’s strategic growth investments have gone forward well, with the battery materials M&A’s, expansions, and projects in Tianjin, Xuzhou, and Zhuhai going forward, doubling capacities, operational upstarts, and upgrades all on track for 2023-2024. The company is also working with its Haverhill factory, doubling the company’s capacity due to digital printing demand.
Also, battery materials momentum is continuing, with revenue in FY22 up 74% to $132M, and FY EBITDA up to $29M, which is a YoY increase of 81%. Cabot is selling its products to 6 of the 8 largest manufacturers of commercial batteries, and programs are on track with all 8 of them. The company has strategic investments in the sector that are also going well, and Cabot is expecting its new platforms with the top 2 producers in China to ramp up in 2023 in terms of overall sales, with agreements with Automotive OEMs already in the works.
The company’s Battery materials segment has exploded, generating $16M in EBITDA in 2021, and expecting over $45M in 2023 – and I believe this to only be a start in how this could develop in the next few years.
Battery materials weren’t the only positive for the quarter and year either – in fact, most things were positive. Reinforcement materials as a sector pushed 60%+ in YoY growth, with EBIT of over $100M, and even performance chemicals, a segment that saw a decline across many other companies active in the same sort of business, saw increases in pre-tax profit of 9% driven mostly by pricing and savings.
Overall, Cabot has not only been able to stand firm and “hold the line”, but the company has also leveraged its expertise and capabilities to position itself very advantageously going forward.
Here are some of these trends I’m talking about – which don’t differ that much from the competition, except in how Cabot has been able to outperform overall.
Battery materials aren’t its own segment. The company has two segments – Reinforcement Materials and Performance Chemicals, and the company’s new operations are part of why things have been working so well.
If we look at the overall results for the segments in FY22, we see that the company has been performing very well – this doesn’t just go for 4Q22, but for the entire fiscal. Dividends have been maintained, Cabot has bought back shares, and spent over $200M in CapEx. At the same time, operations have generated ~$100M in cash flows, and the company’s net debt is down to 1.8x, which is among segment-leading levels here.
Cabot isn’t market-leading in yield – it only yields 2.06% at current levels, but the company has a BBB rating, and a market capitalization of over $4B. What’s more important is that the market has completely failed to take into account Cabot’s coming growth from its performance chemicals expansion and as it increases in importance.
This is, of course, great news for us, because it means that we can buy in at relatively cheap and attractive levels if we’re willing to normalize the company’s earnings at a higher forward level.
Remember, in some ways, Cabot is among the market-leading players, despite its smaller overall size.
It’s execution has been very impressive, and its ambitions have been completely in line with the aforementioned growth objectives that were mentioned back in 2021 on the investor day, which you see in the presentation above.
At 4,500 employees, this is smaller than the companies I usually have in my portfolio, but I believe CBT, despite its smaller market cap, warrants a second look.
Cabot Corporation is also, as we’ve seen here and in previous reports on the company a strong player in China, making an investment in the stock an equally interesting one with exposure to our Asian neighbors.
Cabot sees continued demand for its products here and considers itself a preferred supplier to industries it serves in China (Source).
The company’s 2022 guidance was met, and Cabot has issued its preliminary/first 2023E guidance, and it looks like this.
This does not necessarily mean meeting those objectives, of course. But it’s a good starting point, as I see nothing really outlandish about any of these numbers or assumptions. While the potential recession we’re looking at (which I believe we will see) will impact these assumptions somewhat, I still expect the company to deliver robust results and operating performance in line with the long-term expectations and forecasts.
Cabot presents a very interesting investment potential – and I’ll show you two different ways you can play this thesis in the next few segments – so hang on here.
Valuation for Cabot is convincing in the longer term
Cabot remains relatively undercovered here in SA. I understand the reason, it’s not a very “exciting” company. This also means that it’s my “kind” of company because I like boring businesses that outperform the market. Cabot has done exactly that. Had you invested in Cabot after -09 when the company was incredibly cheap, you could have generated annual RoR upwards of 13-15%, even with the COVID-19 crash.
If you like me, invested after COVID-19, you might already sit on a triple-digit, 250%+ RoR. My own RoR is 234% including FX for Cabot, so I didn’t invest exactly at the “right” time. But I’ve bought, added, bought, and added slowly as the company has been attractive – mostly in line with how I’ve presented the thesis for the business.
The valuation for Cabot is still favorable here, and I wouldn’t call it an exaggeration that you would do yourself a disservice by ignoring the upside present in Cabot corporation.
The company hit its expectations for the 2022 period, which only confirms my previous stance that these forecasts, including the ones for 2023 and 2024, are increasingly realistic. If they can be considered realistic, then you should be able to conclude that there is much to like at this time.
2020 was a bad year. The company’s EPS dropped 50%, or close to it. Since then, the company has been on a tear to prove doubters wrong. 2021 saw record EPS. 2022, however, was the complete opposite, and I expect the next few years to be yet more steps toward a higher and higher EPS.
13-14x is the absolutely lowest range I would consider valid for this company – though I think a working Cabot Corporation can easily be worth 15x P/E. But even at just a mid-point of 13.4x P/E, the company’s annualized potential upside is more than 12.5% per year here.
While there is some forecast uncertainty in terms of how accurate those analysts might typically be, most of those misses have to do with times when the company has underperformed or when macro has influenced things. Outside a chaotic macro, this company is relatively easy to forecast, and I personally wouldn’t worry about this company reaching most of its targets over a longer period of time – they usually do, even if there’s some temporary volatility.
5 analysts follow Cabot as a company – and out of those, 4 are at “Buy” and one is at “outperform”. You can see what this implies. Based on a share price range of $80 on the low side and $98 on the high side, we come to an average of $88/share, which implies an upside of 22% at this time. I consider this target valid.
Cabot’s transformation and focus on its growth vectors over the past few years has resulted in a company that’s in a superb position to capitalize not on momentary or temporary trends, but on fundamental changes in society.
That’s one of the reasons why I’m bullish here.
It doesn’t matter what company makes the products, such as the cars or the screens, they will have to source their raw materials from companies exactly like Cabot.
My previous price target for Cabot was a long-term one that assumes the realization of 2024-2025E results. That one is $115. For the shorter term, and for staying safe here, I would give the company a PT of around $85/share, which still marks a double-digit upside for the conservative business that Cabot is, but which also comes with the potential for far higher upside.
I don’t see much ambivalence or uncertainty that can be accounted for or discounted for here. Macro will continue to do “its thing”, and if we do get into a recession, there is that to consider. However, this is nothing the company can control, and I don’t believe it would make the company an uninvestable prospect in the long-term either.
So, for the time being, I view this in the same way I view peers such as BASF (OTCQX:BASFY).- at the right price, I’m definitely a buyer.
Here is my current thesis for Cabot – but be sure to scroll down to the end to view the options one as well.
Thesis for the common share
- This is an excellent play on necessary commodity chemicals. Cabot is a world market leader in key raw materials and technologies that are required by the modern world. The recent annual results have confirmed the upside in battery materials, and I believe this will grow going forward.
- Couple this with an attractive valuation, and I’m at a “Buy”, viewing the company with an upside to a target of 15X 2024E P/E, or a long-term PT in the triple digits close to $115, or a shorter-term PT for safety of $85/share.
- I’m moving in here – using options – see the next section for details.
Remember, I’m all about:
- Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside that is high enough, based on earnings growth or multiple expansion/reversion.
The company now fulfills every single one of my criteria now – and I do consider it cheap here.
The options thesis
I’ve been able to write attractive Cabot options before. Looking at the options chains today, I was able to find the following prospects for the company.
That’s a 15% annualized RoR to wait for the company to drop nearly 10% based on a 6.36x dividend enhancement factor, or buy it at $62.6 as an effective cost basis. If you’re feeling like you want the company badly, you can go for the $70 strike contracts, which will increase that RoR to almost 40% annually and a cost basis of $64, with what I would view as an almost guaranteed assignment over the next 3 months.
I’ve worked with annualized RoRs for Cabot for around 13-18% for the past few months. I haven’t been assigned yet, but I’ve netted a few thousand worths in options premiums in the time, which I view as attractive.
CBT remains an attractive options play for me here.