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Methanex (MEOH) is the world’s largest producer of methanol, supplying about 17% of the global market. Methanex is headquartered in Canada, and has plants in Chile, Trinidad and New Zealand, all utilizing natural gas as feedstock because methanol can be manufactured much more cheaply from natural gas than from coal. Approximately 39% of global methanol demand is used in the production of formaldehyde, which is used in polymerizing organic molecules and making various plastic resins and vulcanizing rubber. Methanol is also used to make acetic acid, and as a solvent in various industries. Lastly, methanol also has energy uses, and is used to make MTBE, an anti-knock additive in gasoline (MTBE use has been banned in the USA due to contamination of ground water supplies, but its use continues in Europe and the rest of the world), and DME, a fuel additive which can be blended into LPG and gasoline.

Methanex is the lowest cost producer of methanol in the world, and has extensive experience in the industry. There are strong barriers to competition. World-scale methanol plants have to be situated close to sources of natural gas and are very expensive to build, and only the governments of China, Iran and Saudi Arabia have built world-scale plants recently. These advantages have enabled the company to survive major challenges in the past, including the banning of MTBE in the US, and the curtailment of natural gas supplies by Argentina which led to the closing of 3 out of 4 of Methanex’s plants in Chile. Methanol price rises in line with the price of crude oil, due to the energy content in methanol and the cost of natural gas, which also tends to track the price of crude oil. Methanol price has risen from around $330 per ton in June 2007, to around $490 per ton today. This dramatic rise in methanol price has enabled Methanex to maintain profitability despite a major cut in production volumes due to the curtailment of gas supplies to its Chile plants by Argentina since June 2007 (which resulted in Methanex’s global market share slipping from 20% to 17%).

Several factors bode well for Methanex’s future profitability. Firstly, China has recently approved the use of DME as a fuel additive in both LPG and gasoline, and has recently increased tax breaks to promote the use of DME. China initially planned to produce methanol and DME domestically from its vast coal reserves to increase energy self-reliance, but it turned out that producing methanol from coal is extremely expensive, and the poor road system in China made it difficult to transport methanol to coastal cities. In 2008, China shifted from being a net producer of methanol to being a net importer, as methanol shipped to coastal cities from overseas is cheaper than that produced domestically. In addition, Iran is also using DME as a fuel additive to capitalize on its vast natural gas reserves, and other Asian countries are likely to follow suit. To capitalize on these high growth uses of methanol in Asia, Methanex plans to restart a plant in New Zealand in the 3rd quarter of 2008, and is buildng a world-scale plant in Egypt, slated to come online in 2010. In addition, Methanex is actively sourcing natural gas from newly developed fields in Chile, and is expected to restart its 3 idled plants in Chile gradually over several years. Lastly, management has a history of repurchasing company shares. Outstanding shares has decreased by 45% since 2000, and last year, management repurchased the maximum 10% of outstanding shares allowed under Canadian securities law.

While Methanex appears at first glance to be a conventional cyclical commodity company (albeit one with a strong balance sheet and dominant industry position), methanol production actually has interesting characteristics which stabilize revenues to a certain extent. Currently, about 70% of global methanol production is utilized in industrial uses (formaldehyde, acetic acid and others), and 30% is slated for energy uses (currently only MTBE and DME, with an outside chance of methanol use in fuel cells in the future). When crude oil prices rise, consumers spend less on plastics and other industrial products, which causes methanol demand for industrial use to drop. However, this also causes methanol demand for energy uses to increase, and simultaneously causes methanol prices to go up as natural gas demand increases. Thus, demand lost in industrial uses is partially recaptured through additional demand for energy uses. In the future, as the use of DME is popularized in Asia, methanol demand is expected to increase substantially, and methanol demand is expected to be divided 50:50 between industrial and energy uses.

Current 2008 earnings estimates for Methanex range from $2.30 to $2.70 a share, which means the stock is trading at a PE below 10. Capital expenditures are expected to peak in 2008 at $250-300M due to construction of the Egypt facility and the restart of the New Zealand facility, but will then decrease in 2009 through 2010 (to a final baseline level of $100-150M), when the Egypt facility is completed. Methanex has $350M of cash on hand, and a $250M credit line that has not been tapped. The company generates $400-500M of cash from operations annually, and management expects to fund all the planned capital expenditures from operating cash flows and cash on hand, and expects to continue with its modest dividend and share repurchases for the forseeable future. After suffering setbacks in production volumes due to the Chile plant closures, production volumes will finally begin to increase due to the New Zealand facility re-opening, as well as possible alternative sources of natural gas in Chile which may allow the re-opening of closed Chile plants. This will be topped off with a jump in production volumes in 2010 with the opening of the Egypt plant. Although China, Iran and Saudi Arabia have planned methanol plants in construction, many of these plants are targeted for domestic consumption, and global methanol demand is expected to outstrip the planned production increases.

MEOH’s current stock price is based mainly on fear of a global economic recession (since the majority of its sales is not to the US). If the Asian economies do not slip into recessions, then the current stock price is ridiculously low. I took a position MEOH last Monday at $23.06, and of course, the market went immediately against me to the tune of nearly 10%. At this point, I am not particularly concerned as I am a medium-to-long-term investor with a rather high loss tolerance level, and I expect my investment thesis to play out over several years, with MEOH achieving peak earnings in 2010. The current stock market is really a short-term trader’s market, and that is a game I cannot afford to play because I have a day job, which means I cannot spend time gauging the market psychology every morning. So I typically enter limit orders the day before at prices I deem attractive, and occasionally these orders get executed on a day of panic when every other investor is taking a wait-and-see attitude.