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Methanex Corporation (MEOH - Analyst Report) is the world’s largest supplier of methanol. It earned $0.37 per share in the first quarter of 2011 versus last year’s $0.29, surpassing the Zacks Consensus Estimate of $0.23. Quarterly revenues of $619 million also outshone the Zacks Consensus Estimate of $569 million, led by volume and pricing gains. Methanex’s marketing organization was also effective at managing supply chain and shipping operations in the face of challenges such as the delay in the Egypt project and lower than anticipated production from operations in Chile.  However, weak pricing and an increase in global inventories are negatively affecting the company.  Moreover, Methanex is operating its Chilean facilities substantially below capacity due to natural gas supply outages, which resulted in a 39.8% drop in production to 183,000 tons in the reported quarter. We are upgrading the stock to ‘Neutral’ from ‘Underperform’.

Methanex anticipates substantial increases in production in Chile, where gas exploration activity is expected to ramp up over the next few years with the probability for increased natural gas feedstock availability for plants. Methanex anticipates a significant increase in production capacity in 2011 from 1.26 million tons per year. Methanex’s plant in Egypt is in the commissioning phase and produced its first methanol in January 2011, and Medicine Hat, Alberta plant is on track to restart early in the second quarter of 2011. The gas supply outlook in New Zealand also continues to improve and the company is targeting to introduce a second plant in that country in 2012.

Methanex is seeking alternative sources of natural gas and is directly participating in exploration projects to reduce its dependence on natural gas supplies from Argentina. Currently, the company sources natural gas for its production in Chile from the state-owned oil and gas company Empresa Nacional del Petróleo and from GeoPark Chile Limited. The company has a 16% interest in the Otway hydrocarbon exploration block in southern Chile. Methanex is also expecting a 50% participation in the Chilean natural gas exploration block. Due to these natural gas sources, Methanex expects all 4 of its production facilities in Chile, only one of which is functional at present, to be operational within 3–4 years.

Methanex has a strong balance sheet with $240 million of cash on hand and an undrawn credit facility. We believe Methanex is well positioned to continue investing in order to expand the company. Methanex should be in a stronger position to build an excellent track record of returning excess cash to shareholders. It also increased its dividend six times since implementing it in 2002, and has reduced the number of shares outstanding from 173 million in 2000 to the current level of 93 million.

However, Methanex’s business is subject to the risks of operating methanol production facilities, such as unforeseen equipment breakdowns, interruptions in the supply of natural gas and other feedstock, power failures, longer-than-anticipated planned maintenance activities, loss of port facilities, natural disasters or any other event, including unanticipated events beyond control. Such factors could result in a prolonged shutdown of any of the plants or impede the company’s ability to deliver methanol to its customers. A prolonged plant shutdown at any of the major facilities could have an adverse effect on results of operations and the financial condition.

Methanex is witnessing declining production at its Chilean facilities due to lower natural gas supplies from the state-owned energy company Empresa Nacional del Petroleo. Empresa is supplying its natural gas to meet the rising demand in the residential markets in southern Chile. Consequently, operations at the Atlas plant in Chile, which became functional recently, were abandoned due to lack of natural gas. Such production outages are hurting revenues. Methanex predicts further sales declines owing to production disruptions going forward. 

Methanex has been adversely affected by the global economic slowdown. The company operates in a cyclical commodity industry and its financial performance depends principally on the selling price of methanol. Approximately 80% of the world demand for methanol comes from its use in the production of formaldehyde, acetic acid and other chemical derivatives, which in turn, are heavily dependent on the levels of global gross domestic product and change in general economic conditions. Due to the reduced methanol production from its facilities, Methanex has resorted to trading activities. The company is purchasing methanol produced by others through long-term and short-term contracts or on the spot market to meet customer needs. This is resulting in a negative cash margin on the sale of the purchased methanol.

Methanex faces stiff competition from Celanese Corp. (CE - Analyst Report) and Eastman Chemical Co. (EMN - Analyst Report).

Currently, Methanex has a short-term (1 to 3 months) Zacks #3 Rank (Hold) and a long- term Neutral recommendation.

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