Neste Corp. (OHEL:NESTE, Financial), a Finland-based company, has positioned itself as a global leader in renewable fuels and a key contributor to the circular economy. It recently held a Capital Markets Day for investors, which I watched and took notes on.
With a strong focus on safety, innovation and sustainable practices, Neste has achieved remarkable growth and emerged as a frontrunner in the nascent industry of renewable fuels. However, it also faces challenges stemming from raw material uncertainties, rising costs and increased competition. This discussion provides a comprehensive analysis of the company's strengths, weaknesses, opportunities and threats in the renewable fuels sector as well as a look at its financials and its attractiveness as a potential international investment.
Strengths
The company has several factors working in its favor.
First, Neste demonstrates a strong commitment to improving safety performance, steadily reducing process safety event rates and total recordable incident frequencies. Additionally, the company's robust performance in renewable and oil products aligns with its goal of contributing to a circular economy.
Second, the company's return on average capital employed (ROACE) has been steadily improving. It maintains a leverage ratio well below the target of 40%, ensuring financial stability. Further, Neste has achieved record-high sales margins in renewable products, indicating strong market demand and profitability.
Neste's emphasis on research and development also enables it to stay at the forefront of technological advancements. This commitment drives the growth of existing businesses while creating new growth platforms in renewable and circular solutions. For instance, it has a partnership with Airbus (XPAR:AIR, Financial) to develop sustainable aviation fuel technology.
Finally, Neste has set an ambitious target to become carbon neutral by 2035. This commitment further strengthens its sustainability credentials and aligns with global efforts to combat climate change. The company's adherence to standards such as the European Renewable Energy Directive II and III (RED II and III) efficiency standards ensures its products meet regulatory requirements. The company's proprietary NEXBTL method and direct-to-user sales, such as Neste MY SAF for Business, provide additional advantages in the market.
Sales margin and cost breakdown
Neste has witnessed an increase in sales margin, from 779% in 2022 to 945% in the first quarter of 2023. The breakdown of costs affecting the margin includes the following factors:
- The price of biomass-based diesel renewable identification numbers (RINs) decreased from the fourth quarter of 2022 but increased from the first quarter of 2022, impacting the overall margin.
- The price of California low carbon fuel standard credits decreased from the first quarter of 2022, influencing the sales margin.
- While the overall palm oil price decreased from 2022, it increased from the fourth quarter, affecting the sales margin.
- The share of waste and residues in the total feedstock increased to 96% from 2022. The prices of waste and residue feedstock declined more significantly than vegetable oils, leading to a positive impact on the sales margin.
- Neste's focus on cost management and efficiency is evident in its ability to maintain a favorable margin despite various cost factors.
Weaknesses
The company also has a few weaknesses that could hurt its performance.
First, Neste faces uncertainties and volatility in the raw material market, which may impact its profitability. The dependence on local demand and supply, as well as the fluctuating prices of raw materials, pose challenges to the company's operations.
Globally, sustainable aviation fuel costs approximately four times as much as kerosene. Although prices are expected to decrease by 2050, SAF is likely to remain more than double the price of traditional jet fuel. This may limit the widespread adoption of SAF in the aviation industry.
In addition, Neste primarily uses animal fat and used cooking oil, categorized as category B in the Renewable Energy Directive. The limitation on their use to 1.7% of final energy transport poses a constraint on its raw material choices.
Opportunities
Looking ahead, Neste has opportunities to reduce costs by exploring lower-quality waste and residue raw materials in the short to mid-term. This approach could potentially help it cut costs and improve profitability.
Further, by increasing production capacity and expanding its raw material platform through organic growth and acquisitions, Neste can tap into new markets and strengthen its market presence.
Continuously enhancing its research and development capabilities will also allow Neste to drive innovation, develop new materials and improve the efficiency of its renewable fuel production processes.
The demand for jet fuel is projected to increase significantly, offering Neste opportunities for growth in the aviation sector. Stricter regulations on emissions create a favorable environment for the company's sustainable aviation fuel offerings.
Threats
As with any business, the company also faces several riskts.
The first is fluctuations in commodity prices, which could impact its profitability. While there has been an overall decline in prices, geopolitical tensions and market dynamics may introduce uncertainties in the future.
Next, as more competitors enter the market, Neste faces the risk of losing market share. Other companies, including major airlines and sustainable aviation fuel producers, are vying for a share of the rapidly growing renewable fuels industry.
The increasing cost of used cooking oil, one of Neste's primary raw materials, also poses a significant threat to its profitability. The upward trend in prices may erode margins and hinder cost competitiveness.
The margin volatility associated with the production of renewable fuels, including sustainable aviation fuel, introduces risks that could impact Neste's financial performance.
Financials
The company has a quite strong GF Score at 85 out of 100. It is mainly let down by its GF Value as the stock is a possible value trap based on its historical ratios, past financial performanc and analysts' future earnings projections. Further, due to its low leverage, the company has a very strong Altman Z-Score of 5.2 but only a middling Piotroski F-Score of 5 out of 9. The company’s profitability rank is 8 out of 10, thanks to its high profits relative to its industry.
Over time, Neste will phase out of its oil products business to shift its focus on the renewable fuels business. This is because it predicts, based on local regulatory plans, that the demand for oil products in its home market of Scandinavia will dramatically fall in the early 2030s.
Conclusion
Neste has demonstrated impressive strengths in the renewable fuels sector, including its commitment to safety, financial performance, sustainability and innovation. The company's focus on research and development and its pursuit of carbon neutrality position it as a leader in the industry. However, Neste faces challenges related to raw material uncertainties, rising costs and increased competition. To mitigate these threats and capitalize on opportunities, the company must continue to prioritize cost reduction, market expansion and innovation, while remaining vigilant in navigating market dynamics and maintaining a competitive edge in the evolving renewable fuels landscape.
While I am not going to buy the stock anytime soon as the possible value trap warning does concern me, the business is future-facing and is one which is firmly on my watchlist.
Neste’s second-quarter result will be released on July 27.
