Solvay: Rating upgraded to Accumulate on intrinsic value

Given that the stock has declined by 40% since our end-July 2011 downgrade to Hold, we have now decided to upgrade back to Accumulate. We will issue a Flash note later this morning.

We believe a recession is now incorporated in forecasts. We expect REBITDA to decline by 16% in 2012 vs. our lowered pro forma 2011 forecast (pro-forma including Rhodia for a full year). We forecast a decline in the REBITDA margin of the new Solvay group from 16.4% in 2011 (pro forma) to 14.7% in 2012. Although this is still well above the exceptionally low 2009 margin (pro forma margin of Solvay ex-Pharma + Rhodia of roughly 12.2%), we see a number of reasons for that. Firstly, we believe that the destocking effect seen in that period is less of a risk today (stocks were built up during 2008 across the value chain because of inflation fears). Secondly, with raw material price volatility also being lower now there should beless negative impact from inventory accounting on profitability. Thirdly, both Solvay and Rhodia have grown structurally more profitable parts of the portfolio faster since 2009, like Specialty Polymers at Solvay and Advanced Materials at former Rhodia. Fourthly, we should see some benefit from restructuring in the years to come. Note that Solvay has embarked on the € 120m Horizon project while the targeted synergies on Rhodia amount to € 250m. Lastly, Solvay has changed the accounting method on JVs from proportional consolidation to equity consolidation as of 2011. Looking at the pro-forma impact of this accounting change on the 2010 financials (Solvay’s continuing businesses) shows a boost to REBITDA margins of about 65bps. Although we lack the data to recompute REBITDA margins prior to 2010 based on this new accounting method, we would expect the change to lift profit margins for prior years as well.

Solvay is currently trading at 5.2x EV/REBITDA12E and 4.7x EV/REBITDA13E multiple with a 4.7% gross dividend yield. We therefore feel that the valuation is getting attractive enough to compensate for the still-blurred economic picture. We also like the stock for the perceived cost cutting potential (€ 120m Horizon savings target and € 250m savings target fromRhodia integration) over the next few years, the increased emerging market exposure (roughly 40% of revenue post Rhodia) and the strong balance sheet, with net debt (excluding pension gap) to REBITDA below 1x upon pro forma inclusion of Rhodia. We stick to our € 90 price target for now.